SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual report pursuant to Section 13 of the
Securities Exchange Act of 1934, as amended
For the fiscal year ended December 31, 1996
Commission File No.: 0-24802
MONTEREY BAY BANCORP, INC.
(exact name of registrant as specified in its charter)
DELAWARE 77-0381362
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
36 Brennan Street, Watsonville, California 95076
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 722-3885
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of
the Act:
Common Stock, par value $0.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K.
---
The aggregate market value of the voting stock held by non-affiliates
of the registrant, i.e., persons other than the directors and executive officers
of the registrant, was $61,542,969, based upon the last sales price as quoted on
the Nasdaq Stock Market for March 21, 1997.
The number of shares of Common Stock outstanding as of March 21, 1997:
3,593,750
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1997 Annual Meeting of Stockholders are
incorporated by reference into Part III of this Form 10-K.
Portions of the Annual Report to Stockholders for the year ended December 31,
1996 are incorporated by reference into Part II of this Form 10-K.
<PAGE>
INDEX
PAGE
PART I
Item 1. Description of Business.................................... 1
Item 2. Properties................................................. 39
Item 3. Legal Proceedings.......................................... 40
Item 4. Submission of Matters to a Vote of Security Holders........ 40
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters........................................ 40
Item 6. Selected Financial Data.................................... 40
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 40
Item 8. Financial Statements and Supplementary Data................ 41
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure..................... 41
PART III
Item 10. Directors and Executive Officers of the Registrant......... 41
Item 11. Executive Compensation..................................... 41
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................. 41
Item 13. Certain Relationships and Related Transactions............. 41
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K................................................ 42
<PAGE>
PART I
Item 1. Description of Business.
General
Monterey Bay Bancorp, Inc. (the "Company"), a Delaware corporation, is
a savings and loan holding association incorporated in 1995. The Company's
principal business activities consist of the operation of its wholly owned
subsidiary, Monterey Bay Bank (the "Bank"), formerly Watsonville Federal Savings
and Loan Association. Unless otherwise specified herein, references to the
business and operations of the Bank refer to the business and operations of the
Company. The Bank's principal business is attracting retail deposits from the
general public in the area surrounding its branch offices and investing those
deposits, together with funds generated from operations and borrowings, in one-
to four-family residential mortgage loans and, to a lesser extent, in
multi-family, commercial real estate, construction, land and other mortgage
loans. As part of its ongoing operating strategy, the Bank has been diversifying
its loan portfolio by moderately increasing the amount of multi-family,
construction, and commercial real estate lending in its primary market area. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Management Strategy." Loan sales come from loans which have been
designated as held for sale at origination. The Bank retains virtually all the
servicing rights of loans sold. The Bank's revenues are derived principally from
interest on its mortgage loans, and to a lesser extent, interest and dividends
on its investment securities and mortgage backed securities. The Bank's primary
source of funds are deposits, principal and interest payments on loans, advances
from the Federal Home Loan Bank ("FHLB") and to a lesser extent, proceeds from
the sale of loans. Through its wholly-owned subsidiary, Portola Investment
Corporation ("Portola"), the Bank engages in the sale of noninsured insurance
and investment products on an agency basis and acts as trustee on the Bank's
deeds of trust. See "Subsidiary Activities."
Market Area and Competition
The Bank is a community-oriented financial institution which primarily
originates one- to four-family residential mortgage loans within its market
area. The Bank's deposit gathering and lending markets are concentrated in the
communities surrounding its full service offices in Santa Cruz, Monterey and
portions of Santa Clara counties in Central California. The economy in the
Company's primary market area is predominantly agricultural, with some light
manufacturing and tourism industry in the coastal communities on Monterey Bay.
Despite a moderate weakening in real estate values in its primary market area
since 1991, the economic performance in the Company's primary market area
typically mirrors the national economy and shows seasonal economic fluctuations.
The Company faces significant competition both in making loans and in
attracting deposits. The Company's competitors are the financial institutions
operating in its primary market area, many of which are significantly larger and
have greater financial resources than the Company. The Company's competition for
loans comes principally from commercial banks, savings and loan associations,
mortgage banking companies, credit unions and insurance companies. Its most
direct competition for deposits has historically come from savings and loan
associations and commercial banks. In addition, the Company faces increasing
competition for deposits from nonbank institutions such as brokerage firms and
insurance companies in such areas as short-term money market funds, corporate
and government securities funds, mutual funds and annuities. Competition may
also increase as a result of the lifting of restrictions on the interstate
operations of financial institutions.
The Company serves its market area with a variety of mortgage loan
products and other retail financial services. Management considers the Company's
reputation for financial strength and competitive deposit and loan products as
its major competitive advantage in attracting and retaining customers in its
market area.
1
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Lending Activities
Loan Portfolio Composition. The Company's loan portfolio consists
primarily of conventional first mortgage loans secured by one- to four-family
residences. At December 31, 1996, the Company had total gross loans outstanding
of $236.5 million, of which $201.6 million, or 85.2% were one- to four-family,
residential mortgage loans which were primarily owner-occupied. The remainder of
the portfolio consisted of $22.5 million, or 9.5% of multi-family mortgage
loans; $7.5 million, or 3.2% of commercial real estate loans; $4.2 million, or
1.8% of construction and land loans; and nonmortgage loans of $.7 million, or
.3% of total loans. Approximately $9.8 million of the multi-family mortgage
loans were purchased during the period from September 1993 through February 1994
and are secured by apartment buildings located in the greater San Francisco Bay
Area. The Company had $130,000 in loans held for sale at December 31, 1996. At
that same date, 63% of the Company's mortgage loans had adjustable interest
rates. Of the Company's adjustable rate mortgage loans, 47% were indexed to
current market indices and 53% were indexed to the 11th FHLB District Cost of
Funds Index ("11th District Cost of Funds"). At December 31, 1996, 86.7% of the
Company's adjustable rate loans were adjustable within one year. The remainder
had terms to adjustment ranging from one year to five years.
The types of loans that the Company may originate are subject to
federal and state law and regulations. Interest rates charged by the Company on
loans are affected by the demand for such loans and the supply of money
available for lending purposes and the rates offered by competitors. These
factors are, in turn, affected by, among other things, economic conditions,
monetary policies of the federal government, including the Federal Reserve
Board, and legislative tax policies.
2
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The following table sets forth the composition of the Company's loan
portfolio in dollar amounts and as a percentage of the portfolio at the dates
indicated.
<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------------ ------------------ ------------------ ------------------- -----------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
-------- -------- -------- -------- ------ -------- -------- -------- ------- --------
(Dollars in thousands)
<S> <C>
Real estate:
Residential:
One- to four-family...... $201,579 85.22% $199,917 86.29% $216,872 88.36% $166,654 85.64% $86,189 88.99%
Multi-family............. 22,455 9.49% 21,503 9.28% 22,231 9.06% 19,052 9.79% 5,267 5.44%
Commercial real estate...... 7,524 3.18% 4,191 1.81% 2,903 1.18% 2,724 1.40% 1,901 1.96%
Construction and land....... 4,226 1.79% 5,476 2.36% 2,947 1.20% 5,701 2.93% 3,237 3.34%
Other(1)...................... 763 .32% 605 .26% 503 .20% 475 .24% 260 .27%
-------- ------- -------- ------- -------- ------- -------- ------- ------- -------
Total loans.............. 236,547 100.00% 231,692 100.00% 245,456 100.00% 194,606 100.00% 96,854 100.00%
======= ======= ======= ======= =======
Plus (Less):
Undisbursed loan funds...... (1,822) (1,895) (1,178) (3,116) (2,089)
Unamortized premium, net.... 452 651 1,006 1,380 -
Deferred loan fees, net..... (528) (607) (971) (905) (1,053)
Allowance for loan losses... (1,311) (1,362) (808) (387) (167)
-------- -------- -------- -------- -------
Total loans, net......... 233,338 228,479 243,505 191,578 93,545
Less:
Loans held for sale:
One- to four-family(2)...... (130) (92) (16,082) (58,875) -
-------- -------- -------- -------- -------
Total loans held for
investment.............. $233,208 $228,387 $227,423 $132,703 $93,545
======== ========= ======== ======== =======
</TABLE>
- --------------------------------------
(1) Includes loans secured by savings accounts and unsecured loans.
(2) Loans classified as held for sale at December 31, 1993 were transferred to
loans held for investment in April 1994.
3
<PAGE>
Loan Maturity: The following table shows the contractual maturities of the
Company's gross loans at December 31, 1996. The table includes loans held for
sale of $130,000. The table does not include principal repayments. Principal
repayments on total loans totaled $31.2 million for the year ended December 31,
1996.
<TABLE>
<CAPTION>
At December 31, 1996
---------------------------------------------------------------------
One-to Total
Four- Multi- Construction Loans
Family Family Commercial and Land Other(1) Receivable
------ ------ ---------- ------------ -------- ----------
(In thousands)
<S> <C>
Amounts due:
One year or less................................. $ 57 $ - $ - $ 4,131 $763 $4,951
-------- ------- ------ ------- ---- ------
After one year:
More than one year to three years............. 765 - 52 78 - 895
More than three years to five years........... 860 - 1,457 - - 2,317
More than five years to 10 years.............. 5,264 260 187 17 - 5,728
More than 10 years to 20 years................ 7,874 1,326 559 - - 9,759
More than 20 years............................ 186,759 20,869 5,269 - - 212,897
------- ------ ----- ------- ---- -------
Total due after December 31, 1997............. 201,522 22,455 7,524 95 - 231,596
------- ------ ----- ------- ---- -------
Total amount due.............................. 201,579 22,455 7,524 4,226 763 236,547
------- ------ ----- ------- ---- -------
Less:
Undisbursed loan funds................. - - - (1,822) - (1,822)
Unamortized (discounts) premiums....... 491 (39) - - - 452
Deferred loan fees, net................ (452) (50) (17) (9) - (528)
Allowance for loan losses.............. (911) (171) (174) (20) (35) (1,311)
----- ----- ----- ------- ---- -------
Total loans, net.............................. 200,707 22,195 7,333 2,375 728 233,338
Loans held for sale........................... (130) - - - - (130)
----- ------- ------ ------- ----- -----
Loans receivable held for investment.......... $200,577 $22,195 $7,333 $ 2,375 $728 $233,208
======== ======= ====== ======= ==== ========
</TABLE>
- ------------------------------
(1) Includes loans secured by savings accounts and unsecured loans.
4
<PAGE>
The following table sets forth at December 31, 1996, the dollar amount
of gross loans receivable contractually due after December 31, 1997, and whether
such loans have fixed interest rates or adjustable interest rates.
Due After December 31, 1997
Fixed Adjustable Total
----- ---------- -----
(In thousands)
Real estate loans:
One- to four-family................ $85,509 $116,013 $201,522
Multi-family....................... 914 21,514 22,255
Commercial real estate............. 97 7,427 7,524
Construction and land.............. 95 - 95
Other loans...........................
- - -
------- -------- --------
Total loans receivable......... $86,615 $144,981 $231,596
======= ======== ========
Origination, Purchase, Sale and Servicing of Loans. The Company's
mortgage lending activities are conducted primarily through its six branch
offices and approximately 25 wholesale loan brokers who regularly process
applications through the Company. Beginning in 1993, as part of its asset
redeployment and interest rate risk strategy, the Company purchased mortgage
loans originated by other institutions. The determination to purchase specific
loans or pools of loans is based upon criteria substantially similar to the
Company's underwriting policies which consider the financial condition of the
borrower, the location of the underlying property, and the appraised value of
the property, among other factors. As of December 31, 1996, $34.6 million, or
14.9% of the Company's net loans receivable had been purchased from other
financial institutions, primarily consisting of current index, adjustable rate
mortgage loans. Of this amount, 71.9% were one- to four-family residential loans
and 28.1% were multi-family loans. Between November, 1993 and February, 1994 the
Company purchased approximately $10.1 million of multi-family mortgage loans
secured by apartment buildings located in the Greater San Francisco Bay area.
All of the loans purchased had been recently originated and have interest rates
that adjust monthly to the 11th District Cost of Funds. The 11th District Cost
of Funds at December 31, 1996 was 4.84%. The Company did not purchase any loans
during the year ended December 31, 1996. During 1996, the Company entered into a
participation agreement with another financial institution to originate a land
improvement loan, of which the Company's share was $1.4 million. The Company did
not enter into any other participation agreements during the year ended December
31, 1996.
The Company originates both adjustable rate mortgage loans and fixed
rate mortgage loans. Its ability to originate loans is dependent upon the
relative customer demand for fixed rate or adjustable rate mortgage loans, which
is affected by the current and expected future level of interest rates. From
time to time the Company sells fixed rate conforming loans that it originates.
Such sales are dependent on current market rates and opportunities. During the
year ended December 31, 1996, the Company sold $2.6 million of fixed rate
conforming mortgage loans to FHLMC. During the year ended December 31, 1995, the
Company sold $18.5 million of adjustable rate mortgage loans that it originated
during 1994 and 1995 to another financial institution, pursuant to an agreement
which expired in early 1995. Similarly, the Company may sell adjustable rate
mortgage loans in the future, depending upon market opportunities and prevailing
interest rates at the time such a decision is made.
Effective December 1995, the Company adopted Statement of Financial
Accounting Standards No. 122 ("SFAS 122"), Accounting for Mortgage Servicing
Rights. SFAS 122 allows financial institutions that originate mortgages and sell
them into the secondary market to recognize the retained right to service the
loans. This rule amends SFAS 65, which permitted only purchased mortgage
servicing rights to be recognized as an asset. SFAS 122 makes no distinction
between purchased and originated mortgage servicing rights. During 1996 and
1995, the Company recorded $21,000 and $118,000, respectively, of originated
mortgage servicing rights.
5
<PAGE>
The Company recognizes, at the time of sale, the cash gain or loss on
the sale of the loans based on the difference between the net cash proceeds
received and the carrying value of the loans sold. In addition, excess
servicing, which is the present value of any difference between the interest
rate charged to the borrower and the interest rate paid to the purchaser after
deducting a normal servicing fee, is recognizable as an adjustment to the cash
gain or loss. The excess servicing gain or loss is dependent on prepayment
estimates and discount rate assumptions. Historically, such excess servicing
gains or losses have not been material but may become more significant in future
periods. See "- Loan Servicing."
At December 31, 1996 and 1995, the Company was servicing loans for
others with unpaid principal of $61.3 million and $68.8 million, respectively.
Servicing loans for others generally consists of collecting mortgage payments,
maintaining escrow accounts, disbursing payments to investors, and conducting
foreclosure proceedings. Loan servicing income is recorded on the accrual basis
and includes servicing fees from investors and certain charges collected from
borrowers, such as late payment fees.
6
<PAGE>
The following tables set forth the Company's loan originations,
purchases, sales and principal repayments information for the periods indicated:
For the Years Ended December 31,
-----------------------------------
1996 1995 1994
--------- -------- --------
(In thousands)
Gross loans(1):
Beginning balance....................... $229,841 $244,313 $191,965
Loans originated:
One- to four-family(2)(3)........ 27,768 38,630 108,423
Multi-family..................... 1,944 2,515 3,787
Commercial real estate........... 3,363 349 384
Construction and land............ 3,790 5,776 3,687
--------- --------- ---------
Total loans originated........ 36,865 47,270 116,281
Loans purchased..................... - - 3,988
--------- --------- ---------
Total......................... 266,706 291,583 312,234
Less:
Transfer to real estate owned....... 369 297 -
Principal repayments(4)............. 27,238 26,017 29,360
Sales of loans...................... 2,628 18,541 37,383
Securitized loans(5)................ - 14,992 -
Loans in process.................... 1,822 1,895 1,178
--------- --------- ---------
Total loans............................. 234,649 229,841 244,313
Less loans held for sale(2)......... 130 92 16,082
--------- --------- ---------
Ending balance held for investment...... $ 234,519 $ 229,749 $ 228,231
========= ========= =========
(1) Gross loans includes loans receivable held for investment and loans held
for sale, net of deferred loan fees, undisbursed loan funds and
unamortized premiums and discounts.
(2) During 1995, the Company transferred, at market value, $7.4 million of
loans held for sale to loans held for investment, and recorded a lower of
cost or market adjustment of $35,000 through earnings. During 1994, the
Company transferred $58.0 million of loans held for sale to loans held for
investment. At the time of transfer, the fair value of the loans equaled
their cost basis.
(3) Originations of one- to four-family loans decreased during the years ended
December 31, 1996 and 1995 compared to 1994 because of the substantial
increase in one- to four-family loan originations during 1994 to fulfill
an agreement to sell adjustable rate mortgage loans to another financial
institution.
(4) Principal repayments include amortization of premiums, net of discounts;
amortization of deferred loan fees; net changes in nonmortgage loans
receivable; and other adjustments.
(5) During 1995, the Company securitized $15.0 million of mortgage loans and
acquired mortgage backed securities in exchange.
7
<PAGE>
One- to Four-Family Mortgage Lending. The Company offers both fixed
rate and adjustable rate mortgage loans secured by one- to four-family
residences, primarily owner-occupied, located in the Company's primary market
area, with maturities up to thirty years. Substantially all of such loans are
secured by property located in Central California. Loan originations are
generally obtained from existing or past customers and members of the local
communities. In addition, in 1993 and 1994, as part of its asset redeployment
and interest rate risk strategy, the Company purchased mortgage loans
originated by other institutions. The purchased loans consisted of
approximately $39.0 million loans secured by one- to four-family residences
located in Southern California, approximately $11.0 million in loans secured
by one- to four-family residences located in Central California and
approximately $10.1 million in loans secured by multi-family residences
located in Central California. See "Origination, Purchase, Sale and Servicing
of Loans."
At December 31, 1996, the Company's total loans outstanding were $236.5
million, of which $201.6 million, or 85.2%, were one- to four-family residential
mortgage loans. Of the one- to four-family residential mortgage loans
outstanding at that date, 37% were fixed rate loans and 63% were adjustable rate
mortgage loans. The interest rate for 53% of the Company's adjustable rate
mortgage loans are indexed to the 11th District Cost of Funds. The remaining 47%
of adjustable rate mortgage loans are indexed to current market indices. The
Company currently offers a number of adjustable rate mortgage loan programs with
interest rates which adjust monthly or semi-annually. In 1996, the Company also
offered a 25-year fixed rate affordable housing loan, an "easy qualifier" loan,
and 30-year adjustable rate loans with initial three- and five-year fixed rate
terms. In addition, the Company began originating loans subject to negative
amortization in 1996. Negative amortization involves a greater risk to the
Company because during a period of high interest rates the loan principal may
increase above the amount originally advanced. However, the Company believes
that the risk of default on these loans is mitigated by negative amortization
caps, underwriting criteria, relatively low loan to value ratios, and the
stability provided by payment schedules. At December 31, 1996, the Company's
loan portfolio included $4.9 million of mortgage loans subject to negative
amortization, which represented 2.1% of total loans outstanding.
The Company's policy is to originate one- to four-family residential
mortgage loans in amounts up to 80% of the lower of the appraised value or the
selling price of the property securing the loan and up to 97% of the appraised
value or selling price if private mortgage insurance is obtained. Mortgage loans
originated by the Company generally include due-on-sale clauses which provide
the Company with the contractual right to deem the loan immediately due and
payable in the event the borrower transfers ownership of the property without
the Company's consent. Due-on-sale clauses are an important means of adjusting
the rates on the Company's fixed rate mortgage loan portfolio and the Company
has generally exercised its rights under these clauses.
Multi-Family Lending. The Company originates multi-family mortgage
loans generally secured by six to thirty-six unit apartment buildings located in
the Company's primary market area. As part of its operating strategy, the
Company has moderately increased the amount of multi-family mortgage lending in
its primary market area. In reaching its decision on whether to make a
multi-family loan, the Company considers the qualifications of the borrower as
well as the underlying property. Some of the factors to be considered are the
net operating income of the mortgaged premises before debt service and
depreciation, the debt service ratio (the ratio of net earnings to debt
service), and the ratio of loan amount to appraised value. Pursuant to the
Company's underwriting policies, a multi-family adjustable rate mortgage loan
may only be made in an amount up to 65% of the appraised value of the underlying
property. Subsequent declines in the real estate values in the Company's primary
market area have resulted in some increase in the loan-to-value ratio on some
mortgage loans. In addition, the Company generally requires a debt service ratio
of 1.10x. Properties securing a loan are appraised by an independent appraiser
and title insurance is required on all loans. The Company's multi-family loan
portfolio at December 31, 1996 was approximately $22.5 million, or 9.49% of the
Company's total loans outstanding.
When evaluating the qualifications of the borrower for a multi-family
loan, the Company considers the financial resources and income level of the
borrower, the borrower's experience in owning or managing similar
8
<PAGE>
property, and the Company's lending experience with the borrower. The Company's
underwriting policies require that the borrower be able to demonstrate
strong management skills and the ability to maintain the property from current
rental income. The borrower should also present evidence of the ability to
repay the mortgage and a history of making mortgage payments on a timely basis.
In making its assessment of the creditworthiness of the borrower, the Company
generally reviews the financial statements, employment and credit history of
the borrower, as well as other related documentation. The Company's largest
multi-family loan at December 31, 1996 had an outstanding balance of $913,000
and is secured by a 26-unit apartment building located in Sacramento,
California. Included in multi-family loans at December 31, 1996 was $9.8 million
of loans purchased during 1993, which consisted primarily of newly originated
loans secured by apartment buildings in the greater San Francisco Bay Area.
These loans were underwritten to standards substantially similar to those
utilized by the Company in originating loans. See "Origination, Purchase,
Sale and Servicing of Loans."
Loans secured by apartment buildings and other multi-family residential
properties are generally larger and involve a greater degree of risk than one-
to four-family residential mortgage loans. Because payments on loans secured by
multi-family properties are often dependent on successful operation or
management of the properties, repayment of such loans may be subject to a
greater extent to adverse conditions in the real estate market or the economy.
The Company seeks to minimize these risks through its underwriting policies,
which require such loans to be qualified at origination on the basis of the
property's income and debt coverage ratio.
Construction and Land Lending. The Company originates loans for the
acquisition and development of property to contractors and individuals in its
primary market area. The Company's construction loans primarily have been made
to finance the construction of one- to four-family, owner-occupied residential
properties. These loans are primarily adjustable rate loans with construction
terms of one year. The Company's policies provide that construction loans may be
made in amounts up to 80% of the appraised value of the property for
construction of one- to four-family residences and multi-family properties,
subject to the limitation on loans to one borrower. The Company requires an
independent appraisal of the property. Loan proceeds are disbursed in increments
as construction progresses and as inspections warrant. Land loans are determined
on an individual basis, but generally they do not exceed 50% of the actual cost
or current appraised value of the property, whichever is less. The largest
construction loan in the Company's portfolio at December 31, 1996 was $1.4
million and is secured by land located in Stockton, California. At December 31,
1996, the Company had $4.2 million (less undisbursed loan funds of $1.8 million)
of construction and land loans which amounted to 1.8% of the Company's total
portfolio.
As part of its operating strategy, the Company intends to moderately
increase the amount of construction and land lending in its primary market area.
Construction and land financing is generally considered to involve a higher
degree of credit risk than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development compared to the estimated cost (including interest)
of construction. If the estimate of value proves to be inaccurate, the Company
may be confronted with a project, when completed, having a value which is
insufficient to assure full repayment.
Commercial Real Estate Lending. The Company originates commercial real
estate loans that are generally secured by properties used for business purposes
such as small office buildings or a combination of residential and retail
facilities located in the Company's primary market area. The Company's
underwriting procedures provide that commercial real estate loans may be made in
amounts up to the lesser of 65% of the appraised value of the property, or at
the Company's current loans-to-one borrower limit. These loans may be made with
terms up to 25 years for adjustable rate loans and are indexed to the one year
treasury or to the 11th District Cost of Funds. The Company's underwriting
standards and procedures are similar to those applicable to its multi-family
loans, whereby the Company considers the net operating income of the property
and the borrower's expertise, credit history and profitability. The Company has
generally required that the properties securing commercial real estate loans
have debt service coverage ratios of at least 1.10x. The largest
9
<PAGE>
commercial real estate loan in the Company's portfolio at December 31, 1996 was
$1,971,000 and is secured by a 9-unit retail center located in Watsonville,
California. At December 31, 1996, the Company's commercial real estate loan
portfolio was $7.5 million, or 3.2% of total loans.
As part of its operating strategy, the Company has moderately increased
commercial real estate lending in its primary market area. Loans secured by
commercial real estate properties, like multi-family loans, are generally larger
and involve a greater degree of risk than one- to four-family residential
mortgage loans. Because payments on loans secured by commercial real estate
properties are often dependent on successful operation or management of the
properties, repayment of such loans may be subject to a great extent to adverse
conditions in the real estate market or the economy. The Company seeks to
minimize these risks through its underwriting standards, which require such
loans to be qualified on the basis of the property's income and debt service
ratio.
Loan Approval Procedures and Authority. The Board of Directors
authorizes or may limit the lending activity of the Company, establishes the
lending policies of the Company and reviews properties offered as security. The
Board of Directors has authorized the following persons to approve loans up to
the amounts indicated: mortgage loans in amounts of $207,000 and below may be
approved by the Company's staff underwriters; mortgage loans in excess of
$207,000 and up to $250,000 may be approved by the underwriting/processing
manager; mortgage loans in excess of $250,000 and up to $350,000 require the
approval of the Chief Lending Officer; and loans in excess of $350,000 and up to
$500,000 require the approval of the Chief Executive Officer or the President.
Loans in excess of $500,000 and up to $750,000 require the approval of the
Management Loan Committee, which includes the Chief Executive Officer, the
President, and other Senior Officers. Loans in excess of $750,000 and up to $1.0
million require the approval of not less than three of the eight Board members.
A resolution of the Board of Directors is required for mortgage loans in excess
of $1.0 million.
For all loans originated by the Company, upon receipt of a completed
loan application from a prospective borrower, a credit report is ordered and
certain other information is verified by an independent credit agency and, if
necessary, additional financial information is required. An appraisal of the
real estate intended to secure the proposed loan is required which currently is
performed by an independent appraiser designated and approved by the Company.
The Board annually approves the independent appraisers used by the Company and
approves the Company's appraisal policy. The Company's policy is to obtain title
and hazard insurance on all real estate loans. If the original loan amount
exceeds 80% on a sale or refinance of a first trust deed loan or private
mortgage insurance is required, the borrower will be required to make payments
to a mortgage impound account from which the Company makes disbursements for
property taxes and mortgage insurance.
Loan Servicing. The Company also services mortgage loans for others. As
part of its operating strategy, the Company has increased the amount of loan
servicing it performs for others. Loan servicing includes collecting and
remitting loan payments, accounting for principal and interest, making
inspections as required of mortgaged premises, contacting delinquent mortgagors,
supervising foreclosures and property dispositions in the event of unremedied
defaults, making certain insurance and tax payments on behalf of the borrowers
and generally administering the loans. At December 31, 1996, the Company was
servicing $61.3 million of loans for others.
Delinquencies and Classified Assets. Management and the Board of
Directors perform monthly reviews of delinquent loans. The procedures taken by
the Company with respect to delinquencies vary depending on the nature of the
loan and period of delinquency. The Company's policies generally provide that
delinquent mortgage loans be reviewed and that a written late charge notice be
mailed no later than the 15th day of delinquency for mortgage loans. The
Company's policies provide that telephone contact will be attempted to ascertain
the reasons for delinquency and the prospects of repayment. When contact is made
with the borrower at any time prior to foreclosure, the Company will attempt to
obtain full payment or work out a
10
<PAGE>
repayment schedule with the borrower to avoid foreclosure. It is the Company's
general policy to continue to accrue interest on all loans up to 90 days past
due, unless it is determined that the collection of interest and/or principal is
not probable under the contractual terms of the agreement. Property acquired
by the Company as a result of foreclosure on a mortgage loan is classified as
real estate owned and is recorded at the lower of the unpaid principal balance
or fair value less costs to sell at the date of acquisition and thereafter.
Federal regulations and the Company's Internal Asset Review Policy
require that the Company utilize an internal asset classification system as a
means of reporting problem and potential problem assets. The Company has
incorporated the Office of Thrift Supervision ("OTS") internal asset
classifications as a part of its credit monitoring system. The Company currently
classifies problem and potential problem assets as "Substandard," "Doubtful" or
"Loss" assets. An asset is considered "Substandard" if it is inadequately
protected by the current net worth and paying capacity of the obligor or of the
collateral pledged, if any. "Substandard" assets include those characterized by
the "distinct possibility" that the insured institution will sustain "some loss"
if the deficiencies are not corrected. Assets classified as "Doubtful" have all
of the weaknesses inherent in those classified "Substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as "Loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted. Assets
which do not currently expose the insured institution to sufficient risk to
warrant classification in one of the aforementioned categories but possess
weaknesses are designated as "Special Mention."
When an insured institution classifies one or more assets, or portions
thereof, as Substandard or Doubtful, it is required to establish an allowance
for loan losses in an amount deemed prudent by management. These allowances
represent loss allowances which have been established to recognize the inherent
risk associated with lending activities, but which, unlike specific allowances,
have not been allocated to particular problem assets. When an insured
institution classifies one or more assets, or portions thereof, as "Loss," it is
required either to establish a specific allowance for losses equal to 100% of
the amount of the asset so classified or to charge off such amount.
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
OTS which can order the establishment of additional general or specific loss
allowances. The OTS, in conjunction with the other federal banking agencies,
adopted an interagency policy statement on the allowance for loan and lease
losses. The policy statement provides guidance for financial institutions on
both the responsibilities of management for the assessment and establishment of
adequate allowances and guidance for banking agency examiners to use in
determining the adequacy of general valuation guidelines. Generally, the policy
statement recommends that institutions have effective systems and controls to
identify, monitor and address asset quality problems; that management has
analyzed all significant factors that affect the collectibility of the portfolio
in a reasonable manner; and that management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy statement.
As a result of the declines in local and regional real estate market values and
the significant losses experienced by many financial institutions, there has
been a greater level of scrutiny by regulatory authorities of the loan
portfolios of financial institutions undertaken as part of the examination of
institutions by the OTS and the Federal Deposit Insurance Corporation ("FDIC").
While the Company believes that it has established an adequate allowance for
loan losses, actual losses are dependent upon future events and, as such,
further additions to the level of specific and general loan loss allowances may
become necessary. In addition, there can be no assurance that regulators, in
reviewing the Company's loan portfolio, will not request the Company to
materially increase its allowance for loan losses, thereby negatively affecting
the Company's financial condition and earnings at that time.
The Company's Internal Asset Review Committee reviews and classifies
the Company's assets monthly and reports the results of its review to the Board
of Directors. The Company classifies assets in accordance with the management
guidelines described above. At December 31, 1996, the Company had $.8 million of
11
<PAGE>
assets classified as Special Mention. Loans classified as Special Mention are a
result of past delinquencies or other identifiable weaknesses. At December 31,
1996, the largest loan classified as Special Mention had a loan balance of
$124,000. The Company had $4.9 million of assets classified as Substandard,
which included $1.4 million of nonaccrual loans and $3.5 million of loans which
were performing in accordance with their contractual terms but were classified
as Substandard due to identified risk characteristics including delinquent tax
status and a pattern of historical delinquencies. Of the $1.4 million of
nonaccrual loans, all were one- to four-family mortgage loans. At December 31,
1996, the largest loan classified as Substandard had a loan balance of $821,000.
The Company had $1,000 of assets classified as Loss and no assets classified as
Doubtful at December 31, 1996.
The Company generally requires appraisals on an annual basis on
foreclosed properties and, to the extent necessary, properties deemed to be
in-substance foreclosures. The Company generally conducts external inspections
on foreclosed properties and properties deemed in-substance foreclosures on at
least a quarterly basis.
12
<PAGE>
The following table sets forth delinquencies in the Company's loan
portfolio as of the dates indicated:
<TABLE>
<CAPTION>
At December 31, 1996 At December 31, 1995
------------------------------------------------ -------------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
----------------------- ----------------------- ----------------------- ----------------------
Principal Principal Principal Principal
Number Balance Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans of Loans of Loans
---------- ---------- --------- ---------- ------------ ---------- ---------- ---------
(Dollars in thousands)
<S> <C>
One- to four-family......... 3 $ 455 11 $ 1,392 4 $297 8 $1,544
Multi-family................ - - - - 1 170 - -
Commercial.................. - - - - - - - -
Construction and land....... - - - - 1 48 - -
Other....................... 3 1 2 1 - - 2 1
-------- --------- -------- -------- ------- ---- ------ ------
Total....................... 6 $ 456 13 $ 1,393 6 $515 10 $1,545
======== ======= ======== ======= ======= ==== ======= ======
Delinquent loans to total
gross loans............ .14% .19% .06% .59% .22% .22% .37% .67%
</TABLE>
<TABLE>
<CAPTION>
At December 31, 1994
-----------------------------------------------------------
60-89 Days 90 Days or More
--------------------------- ----------------------------
Principal Principal
Number Balance Number Balance
of Loans of Loans of Loans of Loans
---------- ---------- -------------- ----------
(Dollars in thousands)
<S> <C>
One- to four-family.......... 1 $64 4 $711
Multi-family................. - - - -
Commercial................... - - - -
Construction and land........ 3 - - -
Other........................ - - - -
------- ------ ------- ------
Total........................ 4 $64 4 $711
======= ====== ======= ======
Delinquent loans to total
gross loans............. .15% .03% .08% .29%
</TABLE>
13
<PAGE>
Nonaccrual and Past Due Loans. Loans are generally placed on nonaccrual
status when the payment of interest is 90 days or more delinquent, or the
collection of interest and/or principal is not probable under the contractual
terms of the loan agreement. Loans on which the Company has ceased the accrual
of interest constitute the primary component of the portfolio of nonperforming
loans. Nonperforming loans consist of all nonaccrual loans and restructured
loans not performing in accordance with their restructured terms. Nonperforming
assets include all nonperforming loans and REO. The following table sets forth
information regarding nonperforming assets. At December 31, 1996, the Company
had $1.4 million of nonaccrual loans. The effect on interest income due to the
nonaccrual status of these loans was approximately $89,000. The Company
recognized $43,000 of interest income on these loans during 1996. For the year
ended December 31, 1996, the gross interest income which would have been earned
had these loans been performing in accordance with contractual terms was
approximately $132,000. At December 31, 1996, the Company had $354,000 of loans
which met the definition of a troubled debt restructuring, all of which were
current and paying according to the terms of their contractually restructured
agreements on December 31, 1996. The Company had no REO at December 31, 1996 or
any of the dates presented below. The Company does not accrue interest on loans
past due 90 days or more, and accordingly, there were no accruing loans past due
90 days or more at any of the dates presented below.
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ------------ ------------ ----------- -----------
<S> <C>
Nonaccrual loans 90 days or more past due:
Residential real estate:
One- to four-family...................... $ 1,393 $ 1,544 $ 711 $ - $ 644
Multi-family............................. - 830 - - -
Construction and land...................... - 825 - - -
Non-mortgage............................... - 1 - 1 -
------- ------- ----- ------- -----
Total loans on nonaccrual................ 1,393 3,200 711 1 644
Restructured loans not performing in
accordance with their restructured terms....... - - - - -
Real estate owned.............................. - - - - -
------- ------- ----- ------- -----
Total nonperforming assets(1)............ $ 1,393 $ 3,200 $ 711 $ 1 $ 644
======= ======= ===== ======= =====
Allowance for loan losses as a percent
of gross loans receivable(2)............... .56% .59% .33% .20% .17%
Allowance for loan losses as a percent
of total nonperforming loans(1)............ 94.10% 42.56% 113.64% NM(3) 25.93%
Nonperforming loans as a percent
of gross loans receivable(1)(2)............ .59% 1.39% .29% NM(3) .66%
Nonperforming assets as a percent
of total assets(1)......................... .33% .97% .24% NM(3) .40%
</TABLE>
- --------------------------------------
(1) Nonperforming assets consist of nonperforming loans (nonaccrual loans and
restructured loans not performing in accordance with their restructured
terms) and REO. REO consists of real estate acquired through foreclosure
and real estate acquired by acceptance of a deed-in-lieu of foreclosure.
The Company had no REO or nonperforming restructured loans, and
nonperforming loans equaled nonperforming assets, at each of the dates
presented above.
(2) Gross loans receivable includes loans receivable held for investment and
loans held for sale, less undisbursed loan funds, deferred loan origination
fees, and unamortized discounts and premiums.
(3) At December 31, 1993, the Company had $1,000 of nonperforming loans.
Accordingly, ratio data presenting the allowance for loan losses as a
percentage of nonperforming loans for such periods would not be meaningful.
14
<PAGE>
Impaired Loans. A loan is designated as impaired when the Company
determines it may be unable to collect all amounts due according to the
contractual terms of the loan agreement, whether or not the loan is 90 days past
due. Excluded from the definition of impairment are smaller balance homogenous
loans that are collectively evaluated for impairment. In addition, any loans
which meet the definition of a troubled debt restructuring, or are partially or
completely classified as Doubtful or Loss, are considered impaired.
The Company has established a monitoring system for its loans in order
to identify impaired loans, potential problem loans, and to permit periodic
evaluation of the adequacy of allowances for losses in a timely manner. In
analyzing its loans, the Company has established specific monitoring policies
and procedures suitable for the relative risk profile and other characteristics
of loans by type. The Company's residential one- to four-family and non-mortgage
loans, where the aggregate loans to one borrower is less than $500,000, are
considered to be relatively homogeneous and no single loan is individually
significant in terms of its size or potential risk of loss. Therefore, the
Company generally reviews its residential one-to four-family and non-mortgage
loans, where the aggregate loans to one borrower is less than $500,000, by
analyzing the performance and composition of collateral for the portfolio as a
whole. For non-homogeneous loans, including loans to one borrower that in
aggregate exceed $500,000, the Company conducts a periodic review of each loan.
The frequency and type of review is dependent upon the inherent risk attributed
to each loan and the adversity of the loan grade. The Company evaluates the risk
of loss and default for each loan subject to individual monitoring.
Factors considered as part of the periodic loan review process to
determine whether a loan is impaired address both the amount the Company
believes is probable that it will collect and the timing of such collection. As
part of the Company's loan review process the Company considers such factors as
the ability of the borrower to continue meeting the debt service requirements,
assessments of other sources of repayment, and the fair value of any collateral.
Insignificant delays or shortfalls in payment amounts, in the absence of other
facts and circumstances, would not alone lead to the conclusion that a loan is
impaired.
When a loan is designated as impaired, the Company measures impairment
based on the fair value of the collateral of the collateral-dependent loan. The
amount by which the recorded investment of the loan exceeds the measure of the
impaired loan is recognized by recording a valuation allowance with a
corresponding charge to earnings. The Company charges off a portion of an
impaired loan against the valuation allowance when it is probable that there is
no possibility of recovering the full amount of the impaired loan.
The following table identifies the Company's total recorded investment
in impaired loans by type at December 31, 1996 and 1995 (dollars in thousands).
December 31,
------------------------
1996 1995
Residential one- to four-family
non-homogenous loans $ 354 $ 1,544
Multi-family loans 821 830
Commercial real estate loans - -
Construction loans - 825
Non-mortgage loans 1 1
-------- --------
Total impaired loans $ 1,176 $ 3,200
======== ========
For the year ended December 31, 1996, the Company recognized interest
on impaired loans of $145,000. No impaired loans were on nonaccrual status at
December 31, 1996, and therefore no interest was uncollected on impaired
loans. During the year ended December 31, 1996, the Company's average
15
<PAGE>
investment in impaired loans was $.9 million. Valuation allowances on impaired
loans were $82,900 at December 31, 1996.
Allowance for Estimated Loan Losses. The allowance for loan losses is
established through a provision for loan losses based on management's evaluation
of the risks inherent in its loan portfolio and the general economy. The
allowance for loan losses is maintained at an amount management considers
adequate to cover estimated losses in loans receivable which are deemed
probable and estimable. The allowance is based upon a number of factors,
including asset classifications, economic trends, industry experience and
trends, industry and geographic concentrations, estimated collateral values,
management's assessment of the credit risk inherent in the portfolio, historical
loan loss experience, and the Company's underwriting policies. As of December
31, 1996, the Company's allowance for loan losses was .56% of total loans,
compared to .59% as of December 31, 1995. The Company will continue to monitor
and modify its allowances for loan losses as conditions dictate. Various
regulatory agencies, as an integral part of their examination process,
periodically review the Company's valuation allowance. These agencies may
require the Company to establish additional valuation allowances, based on their
judgments of the information available at the time of the examination.
At December 31, 1996, the Company did not have any REO. If the
Company acquires any REO, it will be initially recorded at the lower of the
recorded investment in the loan or the fair value of the related assets at the
date of foreclosure, less costs to sell. Thereafter, if there is a further
deterioration in value, the Company either writes down the REO directly or
provides a valuation allowance and charges operations for the diminution in
value. It is the policy of the Company to charge off consumer loans when it is
determined that they are no longer collectible. The policy for loans secured
by real estate, which comprise the bulk of the Company's portfolio, is to
establish loss reserves in accordance with the Company's asset classification
process, based on generally accepted accounting principles ("GAAP"). It is
the policy of the Company to obtain an appraisal on all real estate acquired
through foreclosure at the time of foreclosure.
The Company did not have any real estate held for investment at
December 31, 1996. If the Company subsequently has real estate held for
investment it will be carried at the lower of cost or net realizable value. All
costs of anticipated disposition are considered in the determination of net
realizable value.
Activity in the Company's allowance for loan losses for the periods
indicated are set forth in the table below (in thousands).
<TABLE>
<CAPTION>
At or For the Year Ended December 31,
------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ----------- ------------ ------------ ----------
<S> <C>
Balance at beginning of year............... $1,362 $ 808 $387 $167 $174
Provision (credit) for loan losses......... 28 663 421 220 (2)
Charge-offs, net........................... (79) (109) - - (5)
------ ------ ---- ---- ----
Balance at end of period................... $1,311 $1,362 $808 $387 $167
====== ====== ==== ==== ====
</TABLE>
16
<PAGE>
The following table sets forth the Company's allowance for loan losses to
total loans, and the percent of loans to total loans in each of the categories
listed at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
- --------------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
--------------------------------- --------------------------------- ---------------------------------
Percent of Percent of Percent of
Percent of Loans in Percent of Loans in Percent of Loans in
Allowance to Each Allowance to Each Allowance to Each
Total Category to Total Category to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans Amount Allowance Total Loans
------ ------------ ----------- ------ ------------ ----------- ------ ------------ -----------
(Dollars in thousands)
<S> <C>
One-to
four family..... $ 911 69.49% 85.22% $1,080 79.30% 86.29% $676 83.66% 88.36%
Multi-family...... 171 13.04% 9.49% 143 10.50% 9.28% 91 11.26% 9.06%
Commercial........ 174 13.27% 3.18% 58 4.26% 1.81% 31 3.84% 1.18%
Construction
and land........ 20 1.53% 1.79% 77 5.65% 2.36% 7 .87% 1.20%
Other............. 35 2.67% .32% 4 .29% .26% 3 .37% .20%
------ ------- ------- ------ ------- ------- ---- ------- -------
Total valuation
allowances........ $1,311 100.00% 100.00% $1,362 100.00% 100.00% $808 100.00% 100.00%
====== ======= ======= ====== ======= ======= ==== ======= =======
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
1993 1992
--------------------------------- ---------------------------------
Percent of Percent of
Percent of Loans in Percent of Loans in
Allowance to Each Allowance to Each
Total Category to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans
------ ------------ ----------- ------ ------------ -----------
<S> <C>
One-to
four family..... $264 68.22% 85.64% $137 82.04% 88.99%
Multi-family...... 60 15.50% 9.79% 11 6.59% 5.44%
Commercial........ 26 6.72% 1.40% 4 2.40% 1.96%
Construction
and land........ 31 8.01% 2.93% 15 8.97% 3.34%
Other............. 6 1.55% .24% - - .27%
---- ------- ------- ---- ------- -------
Total valuation
allowances........ $387 100.00% 100.00% $167 100.00% 100.00%
==== ======= ======= ==== ======= =======
</TABLE>
17
<PAGE>
Investment Activities
Federally chartered savings institutions have the authority to invest
in various types of liquid assets, including United States Treasury obligations,
securities of various federal agencies, certificates of deposit of insured banks
and savings institutions, bankers' acceptances, repurchase agreements and
federal funds. Subject to various restrictions, federally chartered savings
institutions may also invest their assets in commercial paper, investment-grade
corporate debt securities and mutual funds whose assets conform to the
investments that a federally chartered savings institution is otherwise
authorized to make directly. Additionally, the Company must maintain minimum
levels of investments that qualify as liquid assets under OTS regulations. See
"Regulation - Federal Savings Institution Regulation - Liquidity." Historically,
the Company has maintained liquid assets above the minimum OTS requirements and
at a level considered to be adequate to meet its normal daily activities.
The Company's investment activities described herein include
transactions related to short-term investments, investment securities and
mortgage backed securities held by the Company. The investment policies of the
Company as established by the Board of Directors attempt to provide and maintain
liquidity, generate a favorable return on investments without incurring undue
interest rate and credit risk, and complement the Company's lending activities.
Specifically, the Company's policies generally limit investments to government
and federal agency-backed securities and other non-government guaranteed
securities, including corporate debt obligations, that are investment grade. The
Company's policies provide the authority to invest in marketable equity
securities meeting the Company's guidelines and in mortgage backed securities
guaranteed by the U.S. government and agencies thereof and other financial
institutions. At December 31, 1996, the Company had federal funds sold and other
short-term investments, investment securities (including certificates of
deposit) and mortgage backed securities with an aggregate amortized cost of
$168.7 million and a market value of $167.9 million.
At December 31, 1996, the Company had $50.4 million in investment
securities consisting primarily of $14.8 million invested in a short-term
government securities fund and the remainder invested in U.S. government and
agency obligations. The Company's mortgage backed and mortgage related
securities portfolio consists primarily of seasoned fixed rate and adjustable
rate mortgage backed and mortgage related securities. At December 31, 1996, the
Company had approximately $116.8 million in mortgage backed securities insured
or guaranteed by either the FNMA, GNMA, or FHLMC, including $116.6 million in
mortgage backed securities available for sale. Investments in mortgage backed
securities involve a risk that actual prepayments will exceed prepayments
estimated over the life of the security which may result in a loss of any
premium paid for such instruments thereby reducing the net yield on such
securities. In addition, if interest rates increase, the market value of such
securities may be adversely affected.
18
<PAGE>
The Bank had an amount of mortgage backed and investment securities
issued by the following entities which had a total amortized cost in excess of
10% of the Bank's equity at December 31, 1996. These amounts do not include
investment securities and mortgage backed securities held by the Company
(dollars in thousands).
Issuer Amortized Cost Market Value
------ -------------- ------------
Smith Breeden Short-Term Government
Securities Mutual Fund.................... $15,000 $14,799
Federal Home Loan Mortgage Corporation...... 50,429 50,245
Federal National Mortgage Company........... 60,358 60,100
Federal Home Loan Bank...................... 22,000 21,907
Government National Mortgage Association.... 15,786 15,696
19
<PAGE>
The following table sets forth the composition of the Company's
mortgage backed securities portfolio in dollar amounts and in percentages of the
respective portfolios at the dates indicated (dollars in thousands). Available
for sale securities are reflected at fair market value and held to maturity
securities are reflected at amortized cost pursuant to Statement of Financial
Accounting Standards No. 115, Accounting for Certain Investments in Debt an
Equity Securities ("SFAS No. 115").
<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------------------------------------
1996 1995 1994
-------------------------- -------------------------- --------------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------------- ------------ ------------ ------------- ------------ ------------
<S> <C>
Mortgage backed securities:
FNMA........................................ $ 45,243 39.62% $ 23,485 45.57% $ 155 1.07%
FHLMC....................................... 38,206 33.46% 28,046 54.43% - -
GNMA........................................ 15,158 13.27% - - - -
CMOs(1)..................................... 15,590 13.65% - - 14,282 98.93%
-------- ------- -------- ------- --------- -------
Total mortgage backed securities......... 114,197 100.00% 51,531 100.00% 14,437 100.00%
======= ======= =======
Plus (Less):
Unamortized premium (discount), net......... 2,586 1,091 (754)
-------- -------- ---------
Total mortgage backed
securities, net....................... 116,783 52,622 13,683
Less:
Mortgage backed securities available
for sale......................... 116,610 52,417 13,523
-------- -------- ---------
Total mortgage backed securities
held to maturity...................... $ 173 $ 205 $ 160
========= ======== ========
</TABLE>
- ---------------------------------
(1) The CMOs primarily consisted of mortgage backed securities tied to single
current index securities.
20
<PAGE>
The following tables set forth the Company's mortgage backed securities
activities for the periods indicated (dollars in thousands).
<TABLE>
<CAPTION>
For the Year Ended December 31,
-------------------------------
1996 1995 1994
---- ---- ----
<S> <C>
Beginning balance ............................................ $52,622 $13,683 $32,395
Mortgage backed securities purchased - held to maturity... - 69 -
Mortgage backed securities purchased - available for sale. 85,467 43,022 15,216
Mortgage backed securities acquired in exchange for
securitized loans....................................... - 14,992 -
Sales of mortgage backed securities available for sale,
proceeds from sale..................................... (8,427) (13,746) (29,192)
Principal repayments ..................................... (11,776) (6,240) (3,742)
Realized gain (loss) received on sale of
mortgage backed securities............................ 70 (258) 176
Amortization of (premium)/discount........................ (276) (277) (206)
Unrealized gain (loss) on available for sale.............. (897) 1,377 (964)
-------- ------- -------
Ending balance................................................ $116,783 $52,622 $13,683
======== ======= =======
</TABLE>
The following table sets forth certain information regarding the
amortized cost and market values of the Company's mortgage backed securities at
the dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
At December 31,
---------------
1996 1995 1994
-------------------------- ------------------------- --------------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
------------- ------------ ------------------------- ------------ ------------
<S> <C>
Mortgage backed securities:
Available for sale:
GNMA.............................. $ 15,786 $ 15,696
FHLMC............................. 39,110 38,988 $27,984 $28,187
FNMA.............................. 46,410 46,221 24,020 24,230
CMO(1)............................ 15,788 15,705 - - $14,487 $13,523
-------- -------- ------- ------- ------- -------
Total available for sale........ 117,094 116,610 52,004 52,417 14,487 13,523
-------- -------- ------- ------- ------- -------
Held to maturity:
FNMA.............................. 173 169 205 199 160 144
-------- -------- ------- ------- ------- -------
Total held to maturity.......... 173 169 205 199 160 144
-------- -------- ------- ------- ------- -------
Total mortgage backed
securities................... $117,267 $116,779 $52,209 $52,616 $14,647 $13,667
======== ======== ======== ======= ======= =======
</TABLE>
- ----------------------------
(1) The CMOs primarily consisted of mortgage backed securities tied to single
current index securities.
21
<PAGE>
The following table sets forth certain information regarding the
amortized cost and market values of the Company's federal funds sold and other
short-term investments and investment securities at the dates indicated (dollars
in thousands):
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------------------------------
1996 1995 1994
-------------------------------------------------------------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
-------------------------------------------------------------------------
<S> <C>
Federal funds sold and other
short-term investments............ $ 531 $ 531 $ - $ - $ 4,100 $ 4,100
======== ======= ======= ======= ======= =======
Investment securities:
Certificates of deposit(1)........ 199 199 782 782 1,469 1,469
-------- ------- ------- ------- ------- -------
Held to maturity:
U.S. Treasury notes............. 153 152 355 359 395 395
Tennessee Valley bond........... 144 144 145 144
FICO zero coupon bond........... 107 107 290 294 - -
-------- ------- ------- ------- ------- -------
Total held to maturity........ 404 403 790 797 395 395
-------- ------- ------- ------- ------- -------
Available for sale:
U.S. government and federal
agency obligations.............. 35,322 35,156 16,025 16,161 3,001 2,907
Short-term government
securities mutual fund.......... 15,000 14,799 15,000 14,723 15,000 14,848
Common stock.................... 85 106 - -
Tennessee Valley bond........... - - - - 2,000 1,948
-------- ------- ------- ------- ------- -------
Total available for sale...... 50,322 49,955 31,110 30,990 20,001 19,703
-------- ------- ------- ------- ------- -------
Total investment securities......... $ 51,456 $51,088 $32,682 $32,569 $21,865 $21,567
======== ======= ======= ======= ======= =======
</TABLE>
- -----------------------------
(1) Includes certificates of deposit with original maturities of greater than 90
days.
22
<PAGE>
The table below sets forth certain information regarding the amortized
cost, weighted average yields and contractual maturities of the Company's
federal funds sold and other short-term investments, investment securities and
mortgage backed securities as of December 31, 1996.
<TABLE>
<CAPTION>
At December 31, 1996
-----------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years
------------------------ ------------------------ --------------------------
Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield
------------ ----------- ------------ ----------- ------------- ------------
(Dollars in thousands)
<S> <C>
Investment securities:
Certificates of Deposit(1)......... $ 100 7.13% $ 99 7.07% $ - -
-------- ------- ----------
Held to Maturity:
U.S. government and
federal agency obligations.... 260 5.11% 144 5.29% - -
-------- ------- ----------
Available for sale:
U.S. government and
federal agency obligations..... 3,004 5.71% 20,208 6.72% 12,110 7.12%
Short-term government securities
mutual fund.................... 15,000 5.19% - - - -
-------- ------- ----------
Total available for sale....... 18,004 5.28% 20,208 6.72% 12,110 7.12%
-------- ------- ----------
Total investment securities.... $18,364 5.28% $20,451 6.71% $12,110 7.12%
======= ======= -------
Mortgage backed securities:
Held to maturity:
FNMA............................. - - 173 5.12% - -
-------- ------- ----------
Total held for investment...... - - $ 173 5.12% - -
-------- ------- ----------
Available for sale:
FHLMC............................ - - $ 1,909 7.34% - -
GNMA............................. - - - - - -
FNMA............................. - - - - - -
CMO'S............................ - - - - - -
-------- ------- ----------
Total available for sale....... - - 1,909 7.34% - -
-------- ------- ----------
Total mortgage backed
securities.................. - - $ 2,082 7.16% $ - -
======== ======= ==========
</TABLE>
<TABLE>
<CAPTION>
----------------------------------------------------
More than Ten Years Total
------------------------ ---------------------------
Weighted Weighted
Amortized Average Amortized Average
Cost Yield Cost Yield
------------ ----------- ------------ --------------
<S> <C>
Investment securities:
Certificates of Deposit(1)......... $ - - $ 199 7.10%
-------- ---------
Held to Maturity:
U.S. government and
federal agency obligations.... - - 404 5.17%
-------- ---------
Available for sale:
U.S. government and
federal agency obligations..... - - 35,322 6.77%
Short-term government securities
mutual fund.................... - - 15,000 5.19%
-------- -------
Total available for sale....... - - 50,322 6.30%
-------- -------
Total investment securities.... $ - - $50,925 6.29%
======== =======
Mortgage backed securities:
Held to maturity:
FNMA............................. - - 173 5.12%
-------- --------
Total held for investment...... - - $ 173 5.12%
-------- --------
Available for sale:
FHLMC............................ $ 37,201 7.42% $ 39,109 7.41%
GNMA............................. 15,786 7.62% 15,786 7.62%
FNMA............................. 46,410 7.68% 46,410 7.68%
CMO'S............................ 15,788 6.74% 15,788 6.74%
-------- --------
Total available for sale....... 115,185 7.46% 117,094 7.46%
-------- --------
Total mortgage backed $115,185 7.46% $117,266 7.45%
securities................... ======== ========
</TABLE>
- ---------------------------------
(1) Includes certificates of deposit with original maturities of greater than
90 days.
23
<PAGE>
Sources of Funds
General. Deposits, repayments and prepayments on loans and mortgage
backed securities, proceeds from sales of loans and investments, cash flows
generated from operations and FHLB borrowings are the primary sources of the
Company's funds for use in lending, investing and for other general purposes.
Deposits. The Company offers a variety of deposit accounts with a range
of interest rates and terms. The Company's deposits consist of passbook savings,
checking accounts, money market accounts and certificates of deposit. For the
year ended December 31, 1996, certificates of deposit constituted 79.4% of total
average deposits. The flow of deposits is influenced significantly by general
economic conditions, changes in money market rates, prevailing interest rates
and competition. The Company's deposits are obtained predominantly from the
areas in which its branch offices are located. The Company relies primarily on
customer service and long-standing relationships with customers to attract and
retain these deposits; however, market interest rates and rates offered by
competing financial institutions significantly affect the Company's ability to
attract and retain deposits. Certificate accounts in excess of $100,000 are not
actively solicited by the Company nor has the Company since 1992 used brokers to
obtain deposits.
In 1996 the Company assumed $102.1 million of deposit liabilities in
exchange for cash. In 1993, the Company acquired three branch offices which
resulted in the Company assuming total deposit liabilities of $95.3 million.
In response to the rising interest rate environment, the Company offers
two certificate accounts whose interest rate may be adjusted to prevailing
market rates according to the terms of the account. The "multi-flex" certificate
account may have either a seven or seventeen month term. The depositor has the
option to increase the interest rate once during the term to the current quoted
rate, and may withdraw all or a portion of the deposited funds once during the
term of the account without penalty. The seven-month "multi-flex" certificate
account allows the depositor to increase the deposit amount in the account.
Management continually monitors the Company's certificate accounts and, based on
historical experience, management believes it will retain a large portion of
such accounts upon maturity. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
The following table presents the deposit activity of the Company for
the periods indicated (dollars in thousands).
For the year ended December 31,
-----------------------------------
1996 1995 1994
---- ---- ----
Deposits............................ $ 509,649 $ 474,839 $ 299,767
Purchased deposits(1)............... 102,063 - -
Withdrawals......................... (519,685) (484,457) (311,800)
--------- ---------- -----------
Net deposits (withdrawals).......... 92,027 (9,618) (12,033)
Interest credited on deposits....... 10,834 10,592 8,001
--------- ---------- -----------
Total increase (decrease)
in deposits..................... $ 102,861 $ 974 $ (4,032)
========= ========== ===========
- ------------------------------
(1) In December 1996, the Company assumed $ 102. 1 million of deposits from
Fremont Investment and Loan.
24
<PAGE>
At December 31, 1996, the Company had $49.2 million in certificate
accounts in amounts of $100,000 or more maturing as indicated in the following
table. At December 31, 1995, the Company had $42.0 million of certificate
accounts in amounts of $100,000 or more, with a weighted average rate of 5.89%
at year end. The Company does not offer premium rates on jumbo certificate
accounts.
Weighted
Maturity Period Amount Average Rate
- ------------------------------------------ ------------ --------------
(Dollars in thousands)
Three months or less...................... $ 7,218 5.82%
Over three through six months............. 8,868 5.40%
Over six through 12 months................ 16,557 5.41%
Over 12 months............................ 16,573 5.52%
--------
Total............................ $ 49,217 5.51%
========
25
<PAGE>
The following table sets forth the distribution of the Company's
average deposit accounts for the periods indicated and the weighted average
interest rates on each category of deposits presented.
<TABLE>
<CAPTION>
For the Year Ended December 31,
---------------------------------------------------------------------------------------------
1996 1995 1994
----------------------------- --------------------------------- ----------------------------
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Yield Balance Deposits Yield
--------- --------- --------- ----------- ----------- --------- --------- -------- --------
(Dollars in thousands)
<S> <C>
Money market deposits............. $ 19,387 8.65% 3.58% $14,619 6.75% 2.70% $19,773 9.27% 2.32%
Passbook deposits................. 13,381 5.97% 1.90% 15,048 6.95% 2.04% 18,341 8.60% 2.23%
Checking accounts................. 13,485 6.01% .58% 15,012 6.93% .80% 13,851 6.48% .89%
-------- ------- -------- ------- -------- -------
Total.......................... 46,253 20.63% 44,679 20.63% 51,965 24.35%
-------- ------- -------- ------- -------- -------
Certificate accounts:
Three months or less............ 35,720 20.07% 5.57% 29,772 13.75% 5.52% 39,231 18.39% 4.46%
Over three through six months... 37,366 21.00% 5.61% 42,264 19.52% 5.95% 31,725 14.87% 5.32%
Over six through 12 months...... 58,924 33.11% 5.61% 66,272 30.60% 5.31% 27,134 12.72% 5.37%
Over one to three years......... 44,585 25.05% 5.71% 32,492 15.00% 6.22% 59,428 27.85% 3.25%
Over three to five years........ 1,166 .66% 6.65% 735 .34% 7.29% 3,401 1.59% 9.01%
Over five to ten years.......... 204 .11% 7.23% 343 .16% 7.28% 484 .23% 7.36%
-------- ------- -------- ------- -------- -------
Total certificates............. 177,964 79.37% 5.58% 171,878 79.37% 5.69% 161,403 75.65% 4.40%
-------- ------- -------- ------- -------- -------
Total average deposits......... $224,217 100.00% $216,557 100.00% $213,368 100.00%
======== ======= ======= ======= ======== =======
</TABLE>
26
<PAGE>
The following table presents, by various rate categories, the
amount of certificate accounts outstanding at the dates indicated and the
periods to maturity of the certificate accounts outstanding at December 31, 1996
(in thousands).
<TABLE>
<CAPTION>
Period to Maturity from December 31, 1996 At December 31,
-------------------------------------------------------------------- -------------------------------------
Less than One to Two to Three to Four to Over five
One Year Two years Three years Four years Five years years 1996 1995 1994
-------------------------------------------------------------------- -------------------------------------
<S> <C>
Certificate accounts:
0 to 4.00%............. $ 1,347 $ 30 $ 54 $ - $ - $ - $ 1,431 $ 1,747 $ 34,547
4.01 to 5.00%.......... 30,752 361 344 - - - 31,457 12,129 34,728
5.01 to 6.00%.......... 136,600 53,591 3,585 369 360 - 194,505 83,449 64,888
6.01 to 7.00%.......... 16,935 2,394 1,578 323 246 277 21,753 72,200 28,410
7.01 to 8.00%.......... 2,105 448 481 122 155 - 3,311 2,400 1,284
8.01 to 9.00%.......... 5 43 416 47 - - 511 468 533
Over 9.01%............. 106 18 101 37 - 14 276 377 738
-------- ------- ------- ------- ------ ------- -------- -------- --------
Total............... $187,850 $56,885 $ 6,559 $ 898 $ 761 $ 291 $253,244 $172,770 $165,128
======== ======= ======= ======= ====== ======= ======== ======== ========
</TABLE>
27
<PAGE>
Borrowings
From time to time the Company has obtained FHLB advances and entered
into reverse repurchase agreements with the FHLB as an alternative to retail
deposit funds and may do so in the future as part of its operating strategy.
FHLB borrowings may also be used to acquire certain other assets as may be
deemed appropriate for investment purposes. These borrowings are collateralized
primarily by certain of the Company's mortgage loans and mortgage backed
securities and secondarily by the Company's investment in capital stock of the
FHLB. See "Regulation - Federal Home Loan Bank System." Such borrowings are made
pursuant to several different credit programs, each of which has its own
interest rate and range of maturities. The maximum amount that the FHLB will
advance to member institutions, including the Company, fluctuates from time to
time in accordance with the policies of the OTS and the FHLB. At December 31,
1996, the Company had $59.8 million in outstanding borrowings from the FHLB
consisting of $46.8 million of advances and $13.0 million of reverse repurchase
agreements.
The following table sets forth certain information regarding the
Company's borrowed funds at or for the periods indicated (in thousands):
<TABLE>
<CAPTION>
At or For the Years Ended December 31,
--------------------------------------
1996 1995 1994
----------- --------- -----------
<S> <C>
FHLB advances:
Average balance outstanding................. $43,619 $45,744 $38,532
Maximum amount outstanding at any
month-end during the period............. 99,607 68,032 61,000
Balance outstanding at end of period........
46,807 46,520 59,782
Weighted average interest rate during
the period.............................. 5.75% 6.00% 4.58%
Weighted average interest rate at end
of period............................... 5.72% 5.84% 5.82%
<CAPTION
At or For the Years Ended December 31,
--------------------------------------
1996 1995 1994
----------- ---------- ----------
Securities sold under agreements to repurchase:
Average balance outstanding................. $14,644 $14,487 -
Maximum amount outstanding at any
month-end during the period............. 16,648 26,124 -
Balance outstanding at end of period........ 13,000 17,361 -
Weighted average interest rate during
the period.............................. 5.98% 6.06% -
Weighted average interest rate at end
of period............................... 5.94% 5.91% -
</TABLE>
28
<PAGE>
Subsidiary Activities
Portola, a California corporation, is currently engaged on an agency
basis in the sale of insurance, mutual funds and annuity products primarily to
the Company's customers and members of the local community. The Company has
recently expanded Portola's activities to include the sale of credit life
insurance. As of December 31, 1996, Portola had $441,000 in total assets and a
net loss for the year ended December 31, 1996 of $62,000.
Personnel
As of December 31, 1996, the Company had 81 full-time employees and 3
part-time employees. The employees are not represented by a collective
bargaining unit and the Company considers its relationship with its employees to
be good.
REGULATION AND SUPERVISION
General
The Company, as a savings and loan holding company, is required to file
certain reports with, and otherwise comply with the rules and regulations of the
OTS under the Home Owners' Loan Act, as amended (the "HOLA"). In addition, the
activities of savings institutions, such as the Bank, are governed by the HOLA
and the Federal Deposit Insurance Act ("FDI Act").
The Bank is subject to extensive regulation, examination and
supervision by the OTS, as its primary federal regulator, and the FDIC, as the
deposit insurer. The Bank is a member of the Federal Home Loan Bank ("FHLB")
System and its deposit accounts are insured up to applicable limits by the
Savings Company Insurance Fund ("SAIF") managed by the FDIC. The Bank must file
reports with the OTS and the FDIC concerning its activities and financial
condition in addition to obtaining regulatory approvals prior to entering into
certain transactions such as mergers with, or acquisitions of, other savings
institutions. The OTS and/or the FDIC conduct periodic examinations to test the
Bank's safety and soundness compliance with various regulatory requirements.
This regulation and supervision establishes a comprehensive framework of
activities in which an institution can engage and is intended primarily for the
protection of the insurance fund and depositors. The regulatory structure also
gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes. Any change in such
regulatory requirements and policies, whether by the OTS, the FDIC or the
Congress could have a material adverse impact on the Company, the Bank and their
operations. Certain of the regulatory requirements applicable to the Bank and to
the Company are referred to below or elsewhere herein. The description of
statutory provisions and regulations applicable to savings institutions and
their holding companies set forth in this Form 10-K does not purport to be a
complete description of such statutes and regulations and their effects on the
Bank and the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding
company within the meaning of the HOLA. As a unitary savings and loan holding
company, the Company generally will not be restricted under existing laws as to
the types of business activities in which it may engage, provided that the Bank
continues to be a qualified thrift lender ("QTL"). See "Federal Savings
Institution Regulation - QTL Test." Upon any non-supervisory acquisition by the
Company of another savings institution or savings bank that meets the QTL test
and is deemed to be a savings institution by the OTS, the Company would become a
multiple savings and loan holding company (if the acquired institution is held
as a separate subsidiary) and would be subject to extensive
29
<PAGE>
limitations on the types of business activities in which it could engage. The
HOLA limits the activities of a multiple savings and loan holding company and
its non-insured institution subsidiaries primarily to activities permissible
for bank holding companies under Section 4(c)(8) of the Bank Holding Company
Act ("BHC Act"), subject to the prior approval of the OTS, and activities
authorized by OTS regulation.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution or holding company thereof,
without prior written approval of the OTS; acquiring or retaining, with certain
exceptions, more than 5% of a nonsubsidiary company engaged in activities other
than those permitted by the HOLA; or acquiring or retaining control of a
depository institution that is not insured by the FDIC. In evaluating
applications by holding companies to acquire savings institutions, the OTS must
consider the financial and managerial resources and future prospects of the
company and institution involved, the effect of the acquisition on the risk to
the insurance funds, the convenience and needs of the community and competitive
factors.
The OTS is prohibited from approving any acquisition that would result
in a multiple savings and loan holding company controlling savings institutions
in more than one state, subject to two exceptions: (i) the approval of
interstate supervisory acquisitions by savings and loan holding companies and
(ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, HOLA does prescribe such restrictions on subsidiary
savings institutions, as described below. The Bank must notify the OTS 30 days
before declaring any dividend to the Company. In addition, the financial impact
of a holding company on its subsidiary institution is a matter that is evaluated
by the OTS and the agency has authority to order cessation of activities or
divestiture of subsidiaries deemed to pose a threat to the safety and soundness
of the institution.
Federal Savings Institution Regulation
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage (core) capital ratio and an 8% risk-based capital ratio. In
addition, the prompt corrective action standards discussed below also establish,
in effect, a minimum 2% tangible capital standard, a 4% leverage (core) capital
ratio (3% for institutions receiving the highest rating on the CAMEL financial
institution rating system), and, together with the risk-based capital standard
itself, a 4% Tier I risk-based capital standard. Core capital is defined as
common stockholder's equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus, and minority interests in equity
accounts of consolidated subsidiaries less intangibles other than certain
purchased mortgage servicing rights and credit card relationships. The OTS
regulations also require that, in meeting the tangible leverage (core) and
risk-based capital standards, institutions must generally deduct investments in
and loans to subsidiaries engaged in activities not permissible for a national
bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier I (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of 4% and 8%, respectively.
In determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet assets, are multiplied by a risk-weight of 0% to 100%, as
assigned by the OTS capital regulation based on the risks OTS believes are
inherent in the type of asset. The components of Tier I (core) capital are
equivalent to those discussed earlier. The components of supplementary capital
currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock and the allowance for loan and lease losses limited to a maximum
of 1.25% of risk-weighted assets. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
30
<PAGE>
The OTS regulatory capital requirements also incorporate an interest
rate risk component. Savings institutions with "above normal" interest rate risk
exposure are subject to a deduction from total capital for purposes of
calculating their risk-based capital requirements. A savings institution's
interest rate risk is measured by the decline in the net portfolio value of its
assets (i.e., the difference between incoming and outgoing discounted cash flows
from assets, liabilities and off-balance sheet contracts) that would result from
a hypothetical 200 basis point increase or decrease in market interest rates
divided by the estimated economic value of the institution's assets. In
calculating its total capital under the risk-based capital rule, a savings
institution whose measured interest rate risk exposure exceeds 2% must deduct an
amount equal to one-half of the difference between the institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
institution's assets. The Director of the OTS may waive or defer a savings
institution's interest rate risk component on a case-by-case basis. A savings
institution with assets of less than $300 million and risk-based capital ratios
in excess of 12% is not subject to the interest rate risk component, unless the
OTS determines otherwise. For the present time, the OTS has deferred
implementation of the interest rate risk component. At December 31, 1996, the
Bank met each of its capital requirements, in each case on a fully phased-in
basis.
The following table presents the Bank's capital position at December
31, 1996 relative to fully phased - in regulatory requirements:
<TABLE>
<CAPTION>
Excess Capital
----------------------------------
Actual Required (Deficiency) Actual Required
Capital Capital Amount Percent Percent
--------------- -------------- ----------------- --------------- -----------------
(Dollars in thousands)
<S> <C>
Tangible................... $34,440 $6,239 $28,201 8.28% 1.50%
Core (leverage)............ 34,787 12,488 22,299 8.36% 3.00%
Risk-based................. 36,097 15,026 21,071 19.22% 8.00%
</TABLE>
Prompt Corrective Regulatory Action. Under the OTS prompt corrective
action regulations, the OTS is required to take certain supervisory actions
against undercapitalized institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, a savings institution is
considered "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10%, its ratio of Tier I (core) capital to risk-weighted
assets is at least 6%, its ratio of core capital to total assets is at least 5%,
and it is not subject to any order or directive by the OTS to meet a specific
capital level. A savings institution generally is considered "adequately
capitalized" if its ratio of total capital to risk-weighted assets is at least
8%, its ratio of Tier I (core) capital to risk-weighted assets is at least 4%,
and its ratio of core capital to total assets is at least 4% (3% if the
institution receives the highest CAMEL rating). A savings institution that has a
ratio of total capital to weighted assets of less of than 8%, a ratio of Tier I
(core) capital to risk-weighted assets of less than 4% or a ratio of core
capital to total assets of less than 4% (3% or less for institutions with the
highest examination rating) is considered to be "undercapitalized." A savings
institution that has a total risk-based capital ratio less than 6%, a Tier 1
risk-based capital ratio of less than 3% or a leverage ratio that is less than
3% is considered to be "significantly undercapitalized" and a savings
institution that has a tangible capital to assets ratio equal to or less than 2%
is deemed to be "critically undercapitalized." Subject to a narrow exception,
the banking regulator is required to appoint a receiver or conservator for an
institution that is "critically undercapitalized." The regulation also provides
that a capital restoration plan must be filed with the OTS within 45 days of the
date a savings institution receives notice that it is "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized." Compliance
with the plan must be guaranteed by any parent holding company. In addition,
numerous mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on
31
<PAGE>
growth, capital distributions and expansion. The OTS could also take any one
of a number of discretionary supervisory actions, including the issuance of
a capital directive and the replacement of senior executive officers and
directors.
Insurance of Deposit Accounts. Deposits of the Bank are presently
insured by the SAIF. Both the SAIF and the Bank Insurance Fund ("BIF") (the
deposit insurance fund that covers most commercial bank deposits) are
statutorily required to be recapitalized to a 1.25% of insured reserve
deposits ratio. Until recently, members of the SAIF and BIF were paying average
deposit insurance premiums of between 24 and 25 basis points. The BIF met the
required reserve in 1995, whereas the SAIF is not expected to meet or exceed
the required level until 2002 at the earliest. This situation is primarily due
to the statutory requirement that SAIF members make payments on bonds issued
in the late 1980s by the Financing Corporation ("FICO") to recapitalize the
predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC adopted a new
assessment rate schedule of 0 to 27 basis points under which 92% of BIF members
paid an annual premium of only $2,000. With respect to SAIF member institutions,
the FDIC adopted a final rule retaining the existing assessment rate schedule
applicable to SAIF member institutions of 23 to 31 basis points. As long as the
premium differential continued, it may have adverse consequences for SAIF
members, including reduced earnings and an impaired ability to raise funds in
the capital markets. In addition, SAIF members such as the Bank were placed at a
substantial competitive disadvantage to BIF members with respect to pricing of
loans and deposits and the ability to achieve lower operating costs.
On September 30, 1996, the President signed into law the Deposit
Insurance Funds Act of 1996 (the "Funds Act") which, among other things, imposed
a special one-time assessment on SAIF member institutions, including the Bank,
to recapitalize the SAIF. As required by the Funds Act, the FDIC imposed a
special assessment of 65.7 basis points on SAIF assessable deposits held as of
March 31, 1995, payable November 27, 1996 (the "SAIF Special Assessment"). The
SAIF Special Assessment was recognized by the Bank as an expense in the quarter
ended September 30, 1996 and is generally tax deductible. The SAIF Special
Assessment recorded by the Bank amounted to $1.4 million on a pre-tax basis and
$.8 million on an after-tax basis.
The Funds Act also spreads the obligations for payment of the FICO
bonds across all SAIF and BIF members. Beginning on January 1, 1997, BIF
deposits will be assessed for FICO payment of 1.3 basis points, while SAIF
deposits will pay 6.48 basis points. Full prorata sharing of the FICO
payments between BIF and SAIF members will occur on the earlier of January
1, 2000 or the date the BIF and SAIF are merged. The Funds Act specifies
that the BIF and SAIF will be merged on January 1, 1999, provided no savings
associations remain as of that time.
As a result of the Funds Act, the FDIC recently voted to effectively
lower SAIF assessments to 0 to 27 basis points as of January 1, 1997, a range
comparable to that of BIF members. SAIF members will also continue to make the
FICO payments described above. The FDIC also lowered the SAIF assessment
schedule for the fourth quarter of 1996 to 18 to 27 basis points. Management
cannot predict the level of FDIC insurance assessments on an on-going basis,
whether the savings association charter will be eliminated or whether the
BIF and SAIF will eventually be merged.
The Company's assessment rate for fiscal 1996 was 26 basis points
and the premium paid for this period was $516,000. A significant increase
in SAIF insurance premiums would likely have an adverse effect on the operating
expenses and results of operations of the Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC
upon a finding that the institution has engaged in unsafe or unsound practices,
is in an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or the
32
<PAGE>
OTS. The management of the Bank does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
Thrift Chartering Legislation. The Funds Act provides that the BIF
and SAIF will merge on January 1, 1999 if there are no more savings
associations as of that date. That legislation also requires that the
Department of Treasury submit a report to Congress by March 31, 1997 that makes
recommendations regarding a common financial institutions charter, including
whether the separate charters for thrifts and banks should be abolished.
Various proposals to eliminate the federal thrift charter, create a uniform
financial institutions charter and abolish the OTS have been introduced in
Congress. The bills would require federal savings institutions to convert to
a national bank or some type of state charter by a specified date (January 1,
1998 in one bill, June 30, 1998 in the other) or they would automatically
become national banks. Converted federal thrifts would generally be required
to conform their activities to those permitted for the charter selected and
divestiture of nonconforming assets would be required over a two year period,
subject to two possible one year extensions. State chartered thrifts would
become subject to the same federal regulation as applies to state commercial
banks. Holding companies for savings institutions would become subject to the
same regulation as holding companies that control commercial banks, with a
limited grandfather provision for unitary savings and loan holding company
activities. The Bank is unable to predict whether such legislation would be
enacted, the extent to which the legislation would restrict or disrupt its
operations or whether the BIF and SAIF funds will eventually merge.
Loans to One Borrower. Under the HOLA, savings institutions are
generally subject to the limits on loans to one borrower applicable to national
banks. Generally, savings institutions may not make a loan or extend credit
to a single or related group of borrowers in excess of 15% of its unimpaired
capital and surplus. An additional amount may be lent, equal to 10% of
unimpaired capital and surplus, if such loan is secured by readily-marketable
collateral, which is defined to include certain financial instruments and
bullion. At December 31, 1996, the Bank's limit on loans to one borrower was
$5.4 million. At December 31, 1996, the Bank's largest aggregate outstanding
balance of loans to one borrower totaled $2.0 million.
QTL Test. The HOLA requires savings institutions to meet a QTL test.
Under the QTL test, a savings and loan association is required to maintain at
least 65% of its "portfolio assets" (total assets less (i) specified liquid
assets up to 20% of total assets; (ii) intangibles, including goodwill; and
(iii) the value of property used to conduct business) in certain "qualified
thrift investments" (primarily residential mortgages and related investments,
including certain mortgage backed securities) in at least 9 months out of each
12 month period.
A savings institution that fails the QTL test is subject to certain
operating restrictions and may be required to convert to a bank charter. As of
December 31, 1996, the Bank maintained 85.04% of its portfolio assets in
qualified thrift investments and, therefore, met the QTL test.
Limitation on Capital Distributions. OTS regulations impose
limitations upon all capital distributions by savings institutions, such as
cash dividends, payments to repurchase or otherwise acquire its shares,
payments to shareholders of another institution in a cash-out merger and other
distributions charged against capital. The rule establishes three tiers of
institutions, which are based primarily on an institution's capital level.
An institution that exceeds all fully phased-in capital requirements before
and after a proposed capital distribution ("Tier 1 Company") and has not been
advised by the OTS that it is in need of more than normal supervision, could,
after prior notice but without obtaining approval of the OTS, make capital
distributions during a calendar year equal to the greater of (i) 100% of its
net earnings to date during the calendar year plus the amount that would reduce
by one-half its "surplus capital ratio" (the excess capital over its fully
phased-in capital requirements) at the beginning of the calendar year or (ii)
75% of its net income for the previous four quarters. Any additional capital
distributions would require prior regulatory approval. In the event the
Bank's capital fell below its regulatory requirements or the OTS notified it
that it was in need of more than normal supervision, the Bank's ability to
make capital distributions could be restricted. In addition, the OTS could
prohibit a proposed capital distribution by any institution, which would
otherwise be permitted by the
33
<PAGE>
regulation, if the OTS determines that such distribution would constitute an
unsafe or unsound practice. In December 1994, the OTS proposed amendments
to its capital distribution regulation that would generally authorize the
payment of capital distributions without OTS approval provided the payment
does not cause the institution to be undercapitalized within the meaning of
the prompt corrective action regulation. However, institutions in a holding
company structure would still have a prior notice requirement. At December 31,
1996, the Bank was a Tier 1 Bank.
Liquidity. The Company is required to maintain an average daily
balance of specified liquid assets equal to a monthly average of not less than
a specified percentage of its net withdrawable deposit accounts plus
short-term borrowings. This liquidity requirement is currently 5% but may be
changed from time to time by the OTS to any amount within the range of 4% to 10%
depending upon economic conditions and the savings flows of member institutions.
OTS regulations also require each member savings institution to maintain an
average daily balance of short-term liquid assets at a specified percentage
(currently 1%) of the total of its net withdrawable deposit accounts and
borrowings payable in one year or less. Monetary penalties may be imposed for
failure to meet these liquidity requirements. The Bank's average liquidity and
short-term liquidity ratios for December 31, 1996 were 7.74% and 4.79%
respectively, which exceeded the then applicable requirements. The Bank has
never been subject to monetary penalties for failure to meet its liquidity
requirements.
Assessments. Savings institutions are required to pay assessments to
the OTS to fund the agency's operations. The general assessment, paid on a
semi-annual basis, is computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Bank's latest
quarterly thrift financial report. The assessments paid by the Bank for the
fiscal year ended December 31, 1996 totaled $81,000.
Branching. OTS regulations permit nationwide branching by federally
chartered savings institutions to the extent allowed by federal statute. This
permits federal savings institutions to establish interstate networks and
to geographically diversify their loan portfolios and lines of business.
The OTS authority preempts any state law purporting to regulate branching by
federal savings institutions.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates" (e.g.., any company that
controls or is under common control with an institution, including the Company
and its non-savings institution subsidiaries) is limited by Sections 23A and
23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount
of covered transactions with any individual affiliate to 10% of the capital
and surplus of the savings institution. The aggregate amount of covered
transactions with all affiliates is limited to 20% of the savings institution's
capital and surplus. Certain transactions with affiliates are required to
be secured by collateral in an amount and of a type described in Section 23A
and the purchase of low quality assets from affiliates is generally prohibited.
Section 23B generally provides that certain transactions with affiliates,
including loans and asset purchases, must be on terms and under circumstances,
including credit standards, that are substantially the same or at least as
favorable to the institution as those prevailing at the time for comparable
transactions with non-affiliated companies. In addition, savings institutions
are prohibited from lending to any affiliate that is engaged in activities that
are not permissible for bank holding companies and no savings institution may
purchase the securities of any affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors
and 10% shareholders, ("insiders"), as well as entities such persons control, is
governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder.
Among other things, such loans are required to be made on terms substantially
the same as those offered to unaffiliated individuals and to not involve more
than the normal risk of repayment. Recent legislation created an exception for
loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
insiders over other employees. Regulation O also places individual and aggregate
limits on the amount of loans the Bank may
34
<PAGE>
make to insiders based, in part, on the Bank's capital position and requires
certain board approval procedures to be followed.
Enforcement. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring actions
against the institution and all institution-affiliated parties, including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on
an insured institution. Formal enforcement action may range from the issuance
of a capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and an
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. Under the FDI Act, the FDIC has the authority to recommend to the
Director of the OTS enforcement action to be taken with respect to a particular
savings institution. If action is not taken by the Director, the FDIC has
authority to take such action under certain circumstances. Federal law also
establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") and a final rule to implement safety and soundness standards
required under the FDI Act. The Guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
standards set forth in the Guidelines address internal controls and information
systems; internal audit system; credit underwriting; loan documentation;
interest rate risk exposure; asset growth; and compensation, fees and benefits.
If the appropriate federal banking agency determines that an institution fails
to meet any standard prescribed by the Guidelines, the agency may require the
institution to submit to the agency an acceptable plan to achieve compliance
with the standard, as required by the FDI Act. The final rule establishes
deadlines for the submission and review of such safety and soundness compliance
plans when such plans are required.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily checking accounts). During fiscal year 1996, the Federal Reserve
Board regulations generally require that reserves be maintained against
aggregate transaction accounts as follows: for accounts aggregating $52.0
million or less (subject to adjustment by the Federal Reserve Board) the
reserve requirement is 3%; and for accounts greater than $52.0 million, the
reserve requirement is $1.6 million plus 10% (subject to adjustment by the
Federal Reserve Board between 8% and 14%) against that portion of total
transaction accounts in excess of $52.0 million. The first $4.3 million of
otherwise reservable balances (subject to adjustments by the Federal Reserve
Board) are exempted from the reserve requirements. The Bank is in compliance
with the foregoing requirements. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements imposed by the OTS.
35
<PAGE>
FEDERAL AND STATE TAXATION
Federal Taxation
General. The Bank and the Company report their income on a consolidated
basis using the accrual method of accounting and will be subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the IRS during the last
five years. For its 1996 taxable year, the Bank is subject to a maximum federal
income tax rate of 34%.
Bad Debt Reserve. For fiscal years beginning prior to December 31,
1995, thrift institutions which qualified under certain definitional tests and
other conditions of the Internal Revenue Code of 1986 (the "Code") were
permitted to use certain favorable provisions to calculate their deductions from
taxable income for annual additions to their bad debt reserve. A reserve could
be established for bad debts on qualifying real property loans (generally
secured by interests in real property improved or to be improved) under (i) the
Percentage of Taxable Income Method (the "PTI Method") or (ii) the Experience
Method. The reserve for nonqualifying loans was computed using the Experience
Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which
was enacted on August 20, 1996, requires savings institutions to recapture
(i.e., take into income) certain portions of their accumulated bad debt
reserves. The 1996 Act repeals the reserve method of accounting for bad debts
effective for tax years beginning after 1995. Thrift institutions that would be
treated as small banks are allowed to utilize the Experience Method applicable
to such institutions, while thrift institutions that are treated as large banks
(those generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
A thrift institution required to change its method of computing
reserves for bad debts will treat such change as a change in method of
accounting, initiated by the taxpayer, and having been made with the consent of
the IRS. Any Section 481 (a) adjustment required to be taken into income with
respect to such change generally will be taken into income ratably over a
six-taxable year period, beginning with the first taxable year beginning after
1995, subject to the residential loan requirement.
Under the residential loan requirement provision, the recapture
required by the 1996 Act will be suspended for each of two successive taxable
years, beginning with the Bank's current taxable year, in which the Bank
originates a minimum of certain residential loans based upon the average of the
principal amounts of such loans made by the Bank during its six taxable years
preceding its current taxable year.
Under the 1996 Act, for its current and future taxable years, the Bank
is permitted to make additions to its tax bad debt reserves. In addition, the
Bank is required to recapture (i. e., take into income) over a six year period
the excess of the balance of its tax bad debt reserves as of December 31, 1995
over the balance of such reserves as of December 31, 1987.
Distributions. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Bank's unrecaptured tax bad debt reserves (including the
balance of its reserves as of December 31, 1987) to the extent thereof, and then
from the Bank's supplemental reserve for losses on loans, to the extent thereof,
and an amount based on the amount distributed (but not in excess of the amount
of such reserves) will be included in the Bank's income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's income.
36
<PAGE>
The amount of additional taxable income triggered by an non-dividend is
an amount that, when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Thus, if the Bank makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
such distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion its bad debt reserves.
SAIF Recapitalization Assessment. The Funds Act levied a 65.7-cent fee
on every $100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision which states that the
amount of any special assessment paid to capitalize SAIF under this legislation
is deductible under Section 162 of the Code in the year of payment.
Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986,
as amended (the "Code") imposes a tax on alternative minimum taxable income
("AMTI") at a rate of 20%. The excess of the bad debt reserve deduction using
the percentage of taxable income method over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating
loss carryovers of which the Bank currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current earnings
exceeds its AMTI (determined without regard to this preference and prior to
reduction for net operating losses). In addition, for taxable years beginning
after December 31, 1986 and before January 1, 1996, an environmental tax of .12%
of the excess of AMTI (with certain modifications) over $2.0 million is imposed
on corporations, including the Company, whether or not an Alternative Minimum
Tax ("AMT") is paid. The Bank does not expect to be subject to the AMT, but may
be subject to the environmental tax liability.
Dividends Received Deduction and Other Matters. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank own more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
37
<PAGE>
State and Local Taxation
State of California. The California franchise tax rate applicable to
the Bank equals the franchise tax rate applicable to corporations generally,
plus an "in lieu" rate approximately equal to personal property taxes and
business license taxes paid by such corporations (but not generally paid by
banks or financial corporations such as the Bank); however, the total tax rate
cannot exceed 11.7%. Under California regulations, bad debt deductions are
available in computing California franchise taxes using a three or six year
weighted average loss experience method. The Bank and its California subsidiary
file California state franchise tax returns on a combined basis. The Company, as
a savings and loan holding company commercially domiciled in California, is
treated as a financial corporation and subject to the general corporate tax rate
plus the "in lieu" rate as discussed previously for the Bank.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
Additional Item. Executive Officers of the Registrant
The following table sets forth certain information regarding the
executive officers of the Company who are not also directors:
Name Age (1) Position Held With Company
------------------------------ -------- -------------------------------
Marshall G. Delk 42 President and Chief
Operating Officer
Deborah R. Chandler 42 Senior Vice President,
Chief Financial Officer
and Treasurer
Carlene F. Anderson 44 Corporate Secretary
(1) At December 31, 1996
38
<PAGE>
Item 2. Properties.
The Company neither owns or leases any real property. The Company
reimburses the Bank for property and equipment it utilizes per an expense
sharing agreement.
The Company conducts its business through an administrative office
located in Watsonville and seven branch offices, one of which includes a real
estate loan center. The Company believes that its current facilities are
adequate to meet the present and immediately foreseeable needs of the Company.
<TABLE>
<CAPTION>
Original Net Book Value
Year of Property or
Leased Leased Date of Leasehold
or or Lease Improvements at
Location Owned Acquired Expiration December 31, 1996
- ----------------------------------------- ------------- ----------- ----------------- -------------------
<S> <C>
Administrative/Branch Office:
15 Brennan Street Owned 12-31-65 N/A $ 22,252
Watsonville, California 95076
36 Brennan Street Owned 03-02-94 N/A 395,959
Watsonville, California 95076
Branch Offices:
35 East Lake Avenue Owned 12-31-65 N/A 340,280
Watsonville, California 95076
805 First Street Owned 12-01-76 N/A 251,962
Gilroy, California 95020
1400 Munras Avenue Owned(1) 07-07-93 10-30-97 943,590
Monterey, California 93940
1890 North Main Street Owned 07-07-93 N/A 1,172,005
Salinas, California 93906
(Real Estate Loan Center)(2)
1127 South Main Street Leased 08-08-93 07-31-98(3) 40,405
Salinas, California 93901
8071 San Miguel Canyon Road Leased 12-24-93 12-24-03(4) 83,742
Prunedale, California 93907
60 Bay Avenue Owned 12-10-96 N/A 1,101,417
Capitola, California 95020
</TABLE>
- ---------------------------
(1) Majority owned, portion of property leased, with an option to purchase.
(2) The Company's real estate loan center is located in the facilities of the
branch.
(3) The Company has options to extend the lease term for three consecutive
ten-year periods.
(4) The Company has options to extend the lease term for two consecutive
five-year periods.
39
<PAGE>
Item 3. Legal Proceedings.
The Company is not involved in any pending legal proceeding other than
routine legal proceedings occurring in the ordinary course of business. Such
other routine legal proceedings in the aggregate are believed by management to
be immaterial to the Company's financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Common Stock of Monterey Bay Bancorp, Inc. is traded
over-the-counter on the Nasdaq Stock Market under the symbol "MBBC." The stock
began trading on February 15, 1995. As of March 27, 1997, there were 3,593,750
shares outstanding of the Company's common stock. As of December 31, 1996 there
were 337 stockholders of record. This number does not include persons or
entities who hold their stock in nominee or "street" name.
Information regarding quarterly prices for the Company's stock is as
follows:
Quarter Ended Low Bid High Bid
------------- ------- --------
December 31, 1996 $13 3/8 $15 7/8
September 30, 1996 $11 3/8 $13 5/8
June 30, 1996 $11 3/4 $12 3/4
March 31, 1996 $11 $12 3/4
December 31, 1995 $11 1/2 $13
September 30, 1995 $ 9 7/8 $13 1/8
June 30, 1995 $ 9 $10 3/4
March 31, 1995 $ 8 3/4 $ 9 1/2
In the future, the Board of Directors may consider a policy of paying
dividends on the Common Stock. Declarations of dividends by the Board of
Directors, if any, will depend upon a number of factors, including investment
opportunities available to the Company, capital requirements, regulatory
limitations, the Company's financial condition, results of operations, tax
considerations, and general economic conditions. No assurances can be given,
however, that any dividends will be paid or, if commenced, will continue to be
paid.
Item 6. Selected Financial Data.
Selected consolidated financial data for the five years ended December
31, 1996, consisting of data captioned "Selected Consolidated Financial and
Other Data" on page two of the Company's 1996 Annual Report to Stockholders
filed as an exhibit hereto is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
"Management's Discussion and Analysis of Financial Condition and
Results Operations" on pages 4 to 17 of the Company's 1996 Annual Report to
Stockholders filed as an exhibit hereto is incorporated herein by reference.
40
<PAGE>
Item 8. Financial Statements and Supplementary Data.
The Consolidated Statements of Condition of Monterey Bay Bancorp, Inc.
and Subsidiary as of December 31, 1996 and 1995 and the related Consolidated
Statements of Income, Stockholders' Equity and Cash Flows for each of the years
in the three-year period ended December 31, 1996, together with the related
notes and the report of Deloitte and Touche LLP, independent auditors, on pages
18 to 58 of the Company's 1996 Annual Report to Stockholders filed as an exhibit
hereto, are incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information relating to Directors and Executive Officers of the
Registrant is incorporated herein by reference to the Registrant's Proxy
Statement for the Annual Meeting of Stockholders to be held on May 2, 1997,
which will be filed no later than 120 days following the Registrant's Fiscal
Year end. Information concerning executive officers who are not directors is
contained in Part I of this report in reliance on Instruction G of Form 10-K.
Item 11. Executive Compensation.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 2, 1997, excluding the
Compensation Committee Report on Executive Compensation and the Stock
Performance Graph , which will be filed no later than 120 days following the
Registrant's Fiscal Year end.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 2, 1997, which will be filed no
later than 120 days following the Registrant's Fiscal Year end.
Item 13. Certain Relationships and Related Transactions.
The information relating to director and executive compensation is
incorporated herein by reference to the Registrant's Proxy Statement for the
Annual Meeting of Stockholders to be held on May 2, 1997, which will be filed no
later than 120 days following the Registrant's Fiscal Year end.
41
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a)(1) Financial Statements
The following consolidated financial statements of the registrants and
its subsidiaries are filed as a part of this document under Item 8. Financial
Statements and Supplementary Data.
Consolidated Statements of Financial Condition at December 31,
1996 and 1995.
Consolidated Statements of Operations for each of the years in
the three-year period ended December 31, 1996.
Consolidated Statements of Changes in Stockholders' Equity for
each of the years in the three-year period ended December
31, 1996.
Consolidated Statements of Cash Flows for each of the years in
the three-year period ended December 31, 1996.
Notes to Consolidated Financial Statements.
Independent Auditors' Report.
(a)(2) Financial Statement Schedules
All schedules are omitted because they are not required or are not
applicable or the required information is shown in the consolidated financial
statements or notes thereto.
(a)(3) Exhibits
(a) The following exhibits are filed as part of this report:
3.1 Certificates of Incorporation of Monterey Bay Bancorp, Inc.*
3.2 Bylaws of Monterey Bay Bancorp, Inc.*
4.0 Stock Certificate of Monterey Bay Bancorp, Inc.*
10.1 Form of Employment Agreement between Watsonville Federal
Savings and Loan Association and certain executive officers*
10.2 Form of Employment Agreement between Monterey Bay Bancorp,
Inc. and certain executive officers*
10.3 Form of Change in Control Agreement between Watsonville
Federal Savings and Loan Association and certain executive
officers*
10.4 Form of Change in Control Agreement between Monterey Bay
Bancorp, Inc. and certain executive officers*
10.5 Form of Watsonville Federal Savings and Loan Association of
Employee Severance Compensation Plan*
10.6 Watsonville Federal Savings 401(k) Plan*
10.7 Watsonville Federal Savings and Loan Association 1995
Retirement Plan for Executive Officers and Directors*
10.8 Form of Watsonville Federal Savings and Loan Association
Performance Equity Program for Executives**
10.9 Form of Watsonville Federal Savings and Loan Association
Recognition and Retention Plan for Outside Directors**
10.10 Form of Monterey Bay Bancorp, Inc. 1995 Incentive
Stock Option Plan**
10.11 Form of Monterey Bay Bancorp, Inc. 1995 Stock Option Plan for
Outside Directors**
11 Computation of Per Share Earnings
21 Subsidiary information is incorporated herein by reference
to "Part I - Subsidiaries."
42
<PAGE>
23 Consent of Deloitte & Touche LLP
27 Financial Data Schedule
(b) Report on Form 8-K
The Registrant did not file any reports on Form 8-K during
the last quarter of the fiscal year ended December 31, 1996.
* Incorporated herein by reference from the Exhibits to the Registration
Statement on Form S-1, as amended, filed on September 21, 1994, Registration
No. 33-84272.
** Incorporated herein by reference from the Proxy Statement for the Annual
Meeting of Stockholders' filed on July 26, 1995.
43
<PAGE>
Exhibit No. 11. Statement re: Computation of Per Share Earnings for the years
ended December 31, 1996 and 1995.(1)
1996 1995
--------- ---------
Net income $ 852,000 $ 673,000
========== ==========
Weighted average shares outstanding 3,331,870 3,565,197
Common stock equivalents due to dilutive
effect on stock options (208,389) (274,432)
---------- ----------
Total weighted average common shares
and equivalents outstanding 3,123,481 3,290,765
========== ==========
Primary earnings per share $ 0.27 $ 0.17
========== ==========
Total weighted average common shares
and equivalents outstanding 3,123,481 3,290,765
Additional dilutive shares using the end
of period market value versus the
average market value when applying
the treasury stock method(2) N/A N/A
Total weighted average common shares
and equivalents outstanding for fully
diluted computation 3,123,481 3,290,765
========== ==========
Fully diluted earnings per share $ 0.27 $ 0.17
========== ==========
(1) Net income per share is meaningful only for the years ended December 31,
1996 and 1995, since the Company's common stock was issued February 14,
1995 in connection with the Conversion of Monterey Bay Bank (formerly
Watsonville Federal Savings and Loan Association) from mutual to stock form.
Net income and common shares outstanding for the period from February 15,
1995 to December 31, 1995 were used to compute net income per share for the
twelve months ended December 31, 1995.
(2) Fully dilutive earnings per share do not result in dilution of three
percent or more or are anti-dilutive and are, therefore, not separately
presented in the consolidated statements of operations.
44
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MONTEREY BAY BANCORP, INC.
Date:___________________ By:_______________________________
Marshall G. Delk, President and
Chief Operating Officer
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities
and on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
- ---- ----- ----
<S> <C>
President and Chief Operating Officer ____________,1997
- ------------------------ (principal executive officer)
Marshall G. Delk
Senior Vice President, ____________,1997
- ------------------------ Chief Financial Officer and Treasurer
Deborah R. Chandler (principal accounting officer)
Chairman of the Board of Directors and ____________,1997
- ------------------------ Chief Executive Officer
Eugene R. Friend
Director ____________,1997
- ------------------------
P. W. Bachan
Director ____________,1997
- ------------------------
Edward K. Banks
Director ____________,1997
- ------------------------
Steven Franich
Director ____________,1997
- ------------------------
Donald K. Henrichsen
45
<PAGE>
Director ____________,1997
- ------------------------
Gary L. Manfre
Director ____________,1997
- ------------------------
William S. Meidl
Director ____________,1997
- ------------------------
Louis Resetar, Jr.
Director ____________,1997
- ------------------------
McKenzie Moss
</TABLE>
47
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MONTEREY BAY BANCORP, INC.
By: /s/ Marshall G. Delk
_________________________
Marshall G. Delk
DATED: President and Chief Operating Officer
_______________________
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities
and on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C>
/s/ Marshall G. Delk President and Chief Operating , 1997
- ------------------------------------ Officer ---------------------------------
Marshall G. Delk (principal executive officer)
/s/ Deborah R. Chandler Senior Vice President, Chief , 1997
- --------------------------------- Financial Officer and Treasurer ---------------------
Deborah R. Chandler (principal accounting officer)
/s/ Eugene R. Friend Chairman of the Board , 1997
- --------------------------------- of Directors and Chief
Eugene R. Friend Executive Officer
/s/ P.W. Bachan Director , 1997
- ---------------------------------
P.W. Bachan
/s/ Edward K. Banks Director , 1997
- ---------------------------------
Edward K. Banks
/s/ Steven Franich Director , 1997
- ---------------------------------
Steven Franich
/s/ Donald K. Henrichsen Director , 1997
- ---------------------------------
Donald K. Henrichsen
/s/ Gary L. Manfre Director , 1997
- ---------------------------------
Gary L. Manfre
/s/ William S. Meidl Director , 1997
- ---------------------------------
William S. Meidl
/s/ Louis Resetar, Jr. Director , 1997
- ---------------------------------
Louis Resetar, Jr.
/s/ McKenzie Moss Director , 1997
- ---------------------------------
McKenzie Moss
</TABLE>
Exhibit 13
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data set forth below is derived in
part from, and should be read in conjunction with, the Consolidated Financial
Statements and Related Notes of the Company (dollars in thousands).
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------ -------------- ------------- ------------ -----------
<S> <C>
Selected Financial Condition Data:
Total assets.......................... $425,762 $329,768 $298,278 $252,389 $161,240
Loans receivable held for sale........ 130 92 16,082 58,875 -
Investment securities available
for sale(1)....................... 49,955 30,990 19,703 8,235
Investment securities held to
maturity(1)....................... 404 790 395 - 9,506
Mortgage backed securities available
for sale(1)....................... 116,610 52,417 13,523 32,218 3,624
Mortgage backed securities held to
maturity(1)....................... 173 205 160 177 43,495
Loans receivable held for
investment, net(2)................ 233,208 228,387 227,423 132,703 93,545
Deposits.............................. 318,145 215,284 214,310 218,342 130,500
FHLB advances......................... 46,807 46,520 59,782 10,000 10,000
Securities sold under agreements to
repurchase............................ 13,000 17,361 - - -
Equity, substantially restricted...... 45,759 47,604 23,249 23,073 20,197
Nonperforming assets.................. 1,393 1,545 711 1 644
</TABLE>
<TABLE>
<CAPTION>
For the Year Ended December 31,
------------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ------------- ------------- ------------ -----------
<S> <C>
Selected Operating Data:
Interest income....................... $23,986 $22,544 $17,727 $16,048 $13,530
Interest expense...................... 14,333 14,227 9,841 8,253 6,607
------- ------- ------- ------- -------
Net interest income before provision
for loan losses....................... 9,653 8,317 7,886 7,795 6,923
Provision (credit) for loan losses.... 28 663 421 220 (2)
------- ------- ------- ------- -------
Net interest income after provision
(credit) for loan losses.............. 9,625 7,654 7,465 7,575 6,925
Non interest income................... 941 573 1,048 1,961 306
General and administrative expenses(3) 9,091 7,140 6,316 5,235 2,880
------- ------- ------- ------- -------
Income before income tax expense...... 1,475 1,087 2,197 4,301 4,351
Income tax expense.................... 623 414 949 1,786 1,844
------- ------- ------- ------- -------
Net income............................ 852 $673 $ 1,248 $ 2,515 $ 2,507
======= ======= ======= ======= =======
Net income per share(4)............... $ .27 $ .17 N/A N/A N/A
======= ======= ======= ======= =======
</TABLE>
- ------------------------------------
(1) The Company has historically classified its investment and mortgage
backed securities as "held to maturity" or "available for sale." The
Company elected early adoption of Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," during the fiscal year ended December 31, 1993.
(2) The, allowance for estimated loan losses at December 31, 1996, 1995,
1994, 1993 and 1992 was $1,311,000, $1,362,000 $808,000, $387,000,and
$167,000, respectively.
(3) General and administrative expenses for 1996 includes a non-recurring
special insurance premium assessment of $1.4 million.
(4) Net income per share is meaningful only for the twelve months ended
December 31, 1996 and 1995, since the Company's common stock was issued
February 14, 1995 in connection with the Conversion of Monterey Bay Bank
(formerly Watsonville Federal Savings and Loan Association) from mutual
to stock form. Net income and common shares outstanding for the period
from February 15, 1995 to December 31, 1995 were used to compute net
income per share for the 12 months ended December 31, 1995.
2
<PAGE>
<TABLE>
<CAPTION>
At or For the Year Ended
December 31,
--------------------------------------------------------------------
1996 1995 1994 1993 1992
------------- ------------- ------------- ------------- ------------
<S> <C>
Selected Financial Ratios and Other Data(1):
Performance Ratios:
Return on average assets...................... .26% .21% .45% 1.03% 1.58%
Return on average equity...................... 1.83% 1.49% 5.45% 11.47% 12.75%
Average equity to average assets.............. 13.98% 14.04% 8.33% 8.96% 12.41%
Equity to total assets at end of period....... 10.75% 14.44% 7.79% 9.14% 12.53%
Average interest rate spread(2)............... 2.39% 1.98% 2.73% 2.98% 3.86%
Net interest margin(3)........................ 3.00% 2.65% 2.96% 3.27% 4.43%
Average interest earning assets to
average interest bearing liabilities....... 113.76% 114.94% 107.40% 108.49% 113.45%
General and administrative expenses to
average assets............................. 2.74% 2.22% 2.23% 2.14% 1.82%
Regulatory Capital Ratios:
Tangible capital.............................. 8.28% 11.65% 7.74% 8.69% 12.53%
Core capital.................................. 8.36% 11.83% 8.03% 9.14% 12.53%
Risk-based capital............................ 19.22% 24.42% 15.50% 18.70% 23.37%
Asset Quality Ratios:
Nonperforming loans as a percent of
gross loans receivable(4)(5)............... .59% 1.39% .29% NM(6) .66%
Nonperforming assets as a percent of
total assets(5)............................ .33% .97% .24% NM(6) .40%
Allowance for loan losses
as a percent of gross loans receivable(4) .56% .59% .33% .20% .17%
Allowance for loan losses
as a percent of nonperforming loans(5)... 94.10% 42.56% 113.64% NM(6) 25.93%
Number of full-service customer
facilities.................................... 7 6 6 6 3
</TABLE>
- ---------------------------------------------------
(1) Asset Quality Ratios and Regulatory Capital Ratios are end of period
ratios. With the exception of end of period ratios, all ratios are based
on average daily balances during the indicated periods and are annualized
where appropriate.
(2) The average interest rate spread represents the difference between the
weighted average yield on interest earning assets and the weighted
average cost of interest bearing liabilities.
(3) The net interest margin represents net interest income as a percent of
average interest earning assets.
(4) Gross loans receivable includes loans receivable held for investment and
loans held for sale, less undisbursed loan funds, deferred loan fees and
unamortized discounts/premiums.
(5) Nonperforming assets consist of nonperforming loans (nonaccrual loans and
restructured loans not performing in accordance with their restructured
terms) and REO. REO consists of real estate acquired through foreclosure
and real estate acquired by acceptance of a deed-in-lieu of foreclosure.
The Company had no REO or nonperforming restructured loans, and
nonperforming loans equaled nonperforming assets, at each of the dates
presented above.
(6) At December 31, 1993, the Company had $1,000 of nonperforming loans and
no other nonperforming assets. Accordingly, referenced ratio data would
not be meaningful.
3
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Monterey Bay Bancorp, Inc. ("the Company") completed its initial
offering of common stock on February 14, 1995, in connection with the conversion
of Monterey Bay Bank (the "Bank"), formerly Watsonville Federal Savings and Loan
Association, from the mutual to stock form of ownership. The Company utilized
approximately 50% of the net proceeds to acquire all of the issued and
outstanding stock of the Bank. The Company is headquartered in Watsonville,
California and its principal business currently consists of the operations of
its wholly-owned subsidiary, the Bank. The Company had no operations prior to
February 14, 1995, and accordingly, the results of operations prior to that date
reflect only those of the Bank and its subsidiary.
The Company's results of operations are dependent, to a large extent,
on net interest income, which is the difference between the interest and
dividend income it receives on its interest earning assets, (principally loans
and investment securities) and the interest expense, or the cost of funds of its
interest bearing liabilities (principally deposits and, to a lesser extent, FHLB
advances and reverse repurchase agreements). The Company's service charges,
mortgage loan servicing fees, and commissions from the sale of insurance
products and investments through its wholly owned subsidiary also have
significant effects on the Company's results of operations. The Company's
general and administrative expenses consist primarily of employee compensation,
occupancy expenses, federal deposit insurance premiums, data processing fees and
other operating expenses. The Company's results of operations are also
significantly affected by general economic and competitive conditions,
particularly changes in market interest rates, government policies and actions
of regulatory agencies. The Company exceeded all of its regulatory capital
requirements at December 31, 1996.
Interest Rate Risk
The objective of the Company's asset/liability management activities is
to improve earnings by adjusting the type and mix of assets and liabilities to
effectively address changing conditions and risks. Through overall management of
its balance sheet and by controlling various risks, the Company seeks to
optimize its financial returns within safe and sound parameters. Financial
institutions are subject to interest rate risk to the degree that
interest-bearing liabilities reprice or mature on a different basis and at
different times than interest-earning assets.
The principal objective of the Company's interest rate risk management
function is to evaluate the interest rate risk included in certain balance sheet
accounts, determine the level of risk appropriate given the Company's business
focus, operating environment, capital and liquidity requirements and performance
objectives, establish prudent asset concentration guidelines and manage the risk
consistent with Board approved guidelines. The Company's interest rate risk
policies are established and monitored by its Asset/Liability committee
("ALCO"). The ALCO reviews the sensitivity of the Company's net interest income
and market value of equity to interest rate changes. The objective of the
Company's ALCO activities is to improve earnings by adjusting the types of
assets and liabilities to effectively address changing conditions and risks. The
ALCO seeks to reduce the vulnerability of its operations to changes in interest
rates and to manage the ratio of interest rate sensitive assets to interest rate
sensitive liabilities within specified maturities or repricing dates. The ALCO
closely monitors its interest rate risk as such risk relates to its operational
strategies and reports on these matters to the Board of Directors. The extent of
the movement of interest rates, higher or lower, is an uncertainty that could
have a negative impact on the earnings of the Company.
4
<PAGE>
To measure the Company's interest rate sensitivity, a cumulative gap
measure can be used to assess the impact of potential changes in interest rates
on the net interest income. The repricing gap represents the net position of
assets and liabilities subject to repricing in specified time periods. Assets
and liabilities are categorized according to the expected repricing time frames
based on management's judgment.
The following table sets forth the amounts of interest earning assets
and interest bearing liabilities outstanding at December 31, 1996 which are
anticipated by the Company, based upon certain assumptions, to reprice or mature
in each of the future time periods shown. Except as stated below, the amount of
assets and liabilities shown which reprice or mature during a particular period
were determined in accordance with the earlier of term to repricing or the terms
of the asset or liability. It is intended to provide an approximation of the
projected repricing of assets and liabilities at December 31, 1996 on the basis
of contractual maturities, adjusted for anticipated prepayments, and scheduled
rate adjustments within a three-month period and subsequent selected time
intervals. The loan amounts in the table reflect principal balances expected to
be redeployed and/or repriced as a result of contractual amortization and
anticipated early payoffs of adjustable rate loans and fixed rate loans, and as
a result of contractual rate adjustments on adjustable rate loans. For loans on
residential properties, adjustable rate loans and fixed rate loans are projected
to prepay at rates between 6% and 15% annually. Passbook amounts in the table
reflect an assumed run-off of 25% in the first year and 25% annually thereafter.
Money market accounts reflect an assumed run-off of 70% in the first year and
30% thereafter. The Company's interest bearing checking accounts are subject to
immediate withdrawal ($13.9 million) and are assumed to reprice within the first
three months. Based upon the assumptions used in the following table, at
December 31, 1996, the Company's total interest bearing liabilities maturing or
repricing within one year exceeded its total net interest earning assets
maturing or repricing in the same time by $81.2 million, representing a one year
cumulative "gap" ratio, as defined below, as a percentage of total assets of
negative 19.06%. As a result, the Company is vulnerable to increases in interest
rates.
5
<PAGE>
<TABLE>
<CAPTION>
At December 31, 1996
-------------------------------------------------------------------------------------------------
More than 3 More than 6 More than 1 More than 3 More than 5 Non-
3 Months Months to Months to Year to Years to Years to Interest
or Less 6 Months 1 Year 3 Years 5 Years 10 Years Bearing Total
-------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C>
Interest earning assets (1):
Federal funds sold and
other short-term investments.. $ 4,978 $ - $ - $ - $ - $ - $ $ 4,978
Investment securities,
net(2)(3)(5).................. 14,998 1,111 2,149 2,239 18,091 11,970 - 50,558
Loans receivable(2)(4)(5)....... 76,678 53,905 3,825 17,557 34,848 46,443 - 233,256
Mortgage backed
securities(2)(5).............. 8,193 8,192 16,386 67,453 16,559 - - 116,783
FHLB stock...................... 5,040 - - - - - - 5,040
-------- -------- -------- -------- -------- -------- ------ ---------
Total interest earning
assets..................... 109,887 63,208 22,360 87,249 69,498 58,413 - 410,615
Allowance for loan losses....... (431) (303) (21) (99) (196) (261) - (1,311)
-------- -------- -------- -------- -------- -------- ------ ---------
Net interest earning
assets..................... 109,456 62,905 22,338 87,151 69,302 58,152 - 409,304
Non interest earning assets..... - - - - - - 16,458 16,458
-------- -------- -------- -------- -------- -------- ------ ---------
Total assets............. 109,456 62,905 22,338 87,151 69,302 58,152 16,458 425,762
-------- -------- -------- -------- -------- -------- ------ ---------
Interest bearing liabilities:
Money market deposits........... 6,568 6,568 13,137 11,260 - - - 37,534
Passbook deposits............... 839 839 1,678 6,712 3,356 - - 13,423
Checking accounts............... 7,156 - - - - - 6,788 13,944
Certificate accounts............ 50,829 53,172 83,849 63,444 1,659 291 - 253,244
FHLB advances................... 17,650 13,575 7,000 1,000 - 7,582 - 46,807
Securities sold under
agreements to repurchase...... - - 13,000 - - - - 13,000
-------- -------- -------- -------- -------- -------- ------ ---------
Total interest bearing
liabilities................... 83,042 74,154 118,664 82,416 5,015 7,873 6,788 377,952
Noninterest bearing
liabilities................... - - - - - - 2,051 2,051
Equity.......................... - - - - - 45,759 45,759
-------- -------- -------- -------- -------- -------- ------ ---------
Total liabilities and
equity.................. 83,042 74,154 118,664 82,416 5,015 7,873 54,598 425,762
-------- -------- -------- -------- -------- -------- ------ ---------
Interest sensitivity gap(6)........ $ 26,413 $(11,250) $(96,325) $ 4,735 $ 64,287 $ 50,279
======== ======== ======== ======== ======== ========
Cumulative interest
sensitivity gap.................. $ 26,413 $ 15,164 $(81,162) $(76,427) $(12,139) $ 38,140
======== ======== ======== ======== ======== ========
Cumulative interest
sensitivity gap as a percent of
total assets..................... 6.20% 3.56% (19.06%) (17.95%) (2.85%) 8.96%
======== ======== ======== ======== ======== ========
Cumulative net interest earning
assets as a percent of
cumulative interest bearing
liabilities...................... 131.81% 109.65% 70.58% 78.67% 96.66% 110.28%
======== ======== ======== ======== ======== ========
</TABLE>
- --------------------------------------------------------
(1) Interest earning assets are included in the period in which the balances
are expected to be redeployed and/or repriced as a result of anticipated
early payoffs, scheduled rate adjustments, and contractual maturities.
(2) Includes assets available for sale.
(3) Includes $199,000 of certificates of deposit with original maturities
greater than 90 days.
(4) For purposes of the gap analysis, mortgage and other loans are reduced
for loans greater than 90 days past due but are not reduced for the
allowance for loan losses.
(5) Investments and mortgage backed securities are at fair market value.
Assets are reported net of unearned (discount) premium and deferred loan
fees.
(6) Interest sensitivity gap represents the difference between interest
earning assets and interest bearing liabilities.
6
<PAGE>
A cumulative gap measure alone cannot be used to evaluate interest rate
sensitivity because interest rate changes do not affect all categories of assets
and liabilities equally or simultaneously. In measuring interest rate
sensitivity, the Company also uses simulation modeling to estimate the potential
effects of movements in interest rates. Interest rate risk sensitivity estimated
by management, as measured by the change in the net portfolio value of equity as
a percentage of the present value of assets from an immediate 200 basis point
increase in interest rates, was 3.85% and 3.42% at December 31, 1996 and 1995,
respectively.
Analysis of Net Interest Income
Net interest income represents the difference between income on
interest earning assets and expense on interest bearing liabilities. Net
interest income also depends upon the relative amounts of interest earning
assets and interest bearing liabilities and the interest rate earned or paid on
them.
Average Balance Sheet
The following table sets forth certain information relating to the
Company for the fiscal years ended December 31, 1996, 1995 and 1994. The yields
and costs are derived by dividing income or expense by the average balance of
assets or liabilities, respectively, for the periods shown. Average balances are
derived from average daily balances. The yields and costs include fees which are
considered adjustments to yields.
7
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------------------------------
1996 1995 1994
-----------------------------------------------------------------------------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
----------- --------- --------- ------------ -------- --------- ------------ --------- ---------
(Dollars in thousands)
<S> <C>
Assets:
Interest earning
assets:
Federal funds sold
and other
short-term
investments........ $ 3,612 $ 6.97% $ 4,299 $ 276 6.43% $ 3,838 $ 146 3.79%
Investment 252
securities,
net(1)(2).......... 37,593 2,314 6.15% 33,309 2,228 6.69% 20,614 1,257 6.10%
Loans
receivable(3)(6)(7) 231,530 18,015 7.78% 241,744 17,826 7.37% 221,307 14,998 6.76%
Mortgage backed
securities,
net(1)............. 45,635 3,224 7.06% 31,291 2,080 6.65% 18,887 1,205 6.38%
FHLB stock......... 2,986 6.08% 2,657 5.06% 2,386 121 5.40%
-------- ------- -------- ------- -------- -------
Total interest
earning assets... 321,356 $23,986 7.46% 313,300 $22,544 7.20% 267,032 $17,727 6.65%
Non interest ======= ======= =======
earning assets..... 10,849 8,666 7,768
-------- -------- --------
Total assets..... $332,205 $321,966 $274,800
======== ======== ========
Liabilities and
Stockholders' Equity:
Interest bearing
liabilities:
Money market
deposits........... $ 19,387 $ 695 3.58% $ 14,619 $ 395 2.70% $ 19,773 $ 450 2.32%
Passbook deposits.. 13,381 254 1.90% 15,048 308 2.04% 18,341 402 2.23%
Checking accounts.. 13,485 78 0.58% 10,781 120 .80% 10,583 121 .89%
Certificate
accounts........... 177,964 9,922 5.58% 171,878 9,779 5.69% 161,403 6,981 4.40%
-------- ------- -------- ------- -------- -------
Total savings
accounts....... 224,217 10,949 4.88% 212,326 10,602 4.99% 210,100 7,954 3.85%
FHLB advances...... 43,619 2,509 5.75% 45,744 2,746 6.00% 38,532 1,887 4.58%
Securities sold
under agreements
to repurchase.... 14,644 875 5.98% 14,497 879 6.06% - -
-------- ------- -------- ------- -------- -------
Total interest
bearing
liabilities...... 282,480 $14,333 5.07% 272,567 $14,227 5.22% 248,632 $ 9,841 3.92%
======= ======= =======
Non interest bearing
liabilities........ 3,284 4,231 3,268
-------- -------- --------
Total liabilities 285,764 276,798 251,900
Stockholders' equity. 46,441 45,168 22,900
-------- -------- --------
Total liabilities
and stockholders'
equity............. $332,205 $321,966 $274,800
======== ======== ========
Net interest rate
spread(4)............ 2.39% 1.98% 2.73%
Net interest
margin(5)............ 3.00% 2.65% 2.96%
Ratio of interest
earning assets to
interest bearing
liabilities.......... 113.76% 114.94% 107.40%
</TABLE>
- --------------------------------------------------
(1) Includes related assets available for sale and unamortized discounts and
premiums.
(2) Amount includes certificates of deposit with original maturities greater
than 90 days.
(3) Amount is net of deferred loan fees, loan discounts and premiums, loans
in process, and loan loss allowances, and includes loans held for sale.
(4) Net interest rate spread represents the difference between the yield on
average interest earning assets and the cost of average interest bearing
liabilities.
(5) Net interest margin represents net interest income divided by average
interest earning assets.
(6) For purposes of these calculations, the nonaccruing loans receivable have
been included in the average balances.
(7) Loan fees recognized for the year ended December 31, 1996 were $217,000.
8
<PAGE>
Rate/Volume Analysis
The following table presents the extent to which changes in interest
rates and changes in the volume of interest earning assets and interest bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to: (i) changes attributable to changes in volume (changes in volume
multiplied by prior rate); (ii) changes attributable to changes in rate (changes
in rate multiplied by prior volume); and (iii) the net change. The changes
attributable to the combined impact of volume and rate have been allocated
proportionately to the changes due to volume and the changes due to rate.
<TABLE>
<CAPTION>
Year Ended December 31, 1996 Year Ended December 31, 1995
Compared to Compared to
Year Ended December 31, 1995 Year Ended December 31, 1994
---------------------------------------- ---------------------------------
Increase (decrease) due to Increase (decrease) due to
Average Average
Volume Rate Net Volume Rate Net
------------- ------------- ----------- ---------- ------------ ---------
<S> <C>
Interest earning assets:
Federal funds sold and
other short-term investments............... ($41) $17 ($24) $27 $103 $130
Investment securities, net (1)(2).......... 358 (272) 86 788 183 971
Loans receivable, net(2)................... (1,019) 1,208 189 1,425 1,403 2,828
Mortgage backed securities, net(2)......... 963 181 1,144 794 81 875
FHLB stock................................. 19 28 47 38 (25) 13
------- ------ ------ ------ ------ ------
Total interest earning assets........... 280 1,162 1,442 3,072 1,745 4,817
------- ------ ------ ------ ------ ------
Interest bearing liabilities:
Money market deposits...................... 150 150 300 (92) 37 (55)
Passbook deposits.......................... (33) (21) (54) (66) (28) (94)
Checking accounts.......................... 12 (54) (42) 1 (2) (1)
Certificate accounts....................... 356 (213) 143 593 2,205 2,798
FHLB advances.............................. (125) (112) (237) 343 516 859
Securities sold under agreements to
repurchase................................. 8 (12) (4) 879 - 879
------- ------ ------ ------ ------ ------
Total interest bearing liabilities...... 368 (262) 106 1,658 2,728 4,386
------- ------ ------ ------ ------ ------
Net change in net interest income............ ($88) $1,424 $1,336 $1,414 $(983) $431
======= ====== ====== ====== ====== ======
</TABLE>
(1) Includes certificates of deposit with original maturities greater than 90
days.
(2) Includes assets available for sale.
9
<PAGE>
Comparison of Operating Results for the Years Ended December 31, 1996 and
December 31, 1995
General
The Company recorded net income of $852,000 for the year ended December
31, 1996, compared to $673,000 for the year ended December 31, 1995. The fully
diluted earnings per share for the year ended December 31, 1996 was $.27,
compared to $.17 per share for the year ended December 31, 1995. Included in net
income for the year ended December 31, 1996 was a non-recurring expense of
$1,387,000 ($815,000 net of taxes) resulting from the federally mandated
recapitalization of the Savings Association Insurance Fund (SAIF) on September
30, 1996. Excluding the non-recurring special insurance premium assessment, net
income would have been $1.7 million, or $.53 per share for the year ended
December 31, 1996. The improvement in earnings, exclusive of the special SAIF
insurance assessment, was the result of higher net interest income, a reduction
in the provision for loan losses, and increased revenue from customer service
charges and mortgage loan servicing income in 1996, partially offset by higher
noninterest expenses. Implementation of the Company's strategic decision to
transition from a traditional savings institution to a community banking
orientation resulted in an increase in general and administrative expenses which
are expected to continue to increase as the Company expands its branch locations
and product lines. The planned benefits of this transition, increased net
interest margin and fee income, are expected to lag behind the increase in
expenditures. Increases in average yields earned on earning assets, in addition
to a decline in the Company's cost of deposits, increased the Company's net
interest margin to 3.00% for the year ended December 31, 1996, from 2.65% for
the year ended December 31, 1995.
The operating results of the Company for the year ended December 31,
1996 were influenced by the December 1996 assumption of $102.1 million of
deposit liabilities from Fremont Investment and Loan for an approximately
equivalent amount of cash. No fixed assets were acquired in the transaction. The
cash was reinvested in various mortgage backed securities and other investments.
Also during the fourth quarter of 1996, the Company purchased a former First
Interstate Bank branch in Capitola, California, which began operations as a full
service bank branch on January 6, 1997. The expansion activity resulted in an
increase in general and administrative expenses for the year ended December 31,
1996.
Interest Income
Interest income for the year ended December 31, 1996 increased by $1.4
million, or 6.4%, to $24.0 million compared to $22.6 million for the year ended
December 31, 1995. Interest income from loans, which accounted for 75.1% of
total interest income for the year ended December 31, 1996, increased by $.2
million, or 1.1%, due to an increase in the Company's weighted average yield on
loans receivable to 7.78% for the year ended December 31, 1996, compared to
7.37% for the previous year, partially offset by a reduction in average
outstanding loan balances during the same period. Interest income on mortgage
backed securities totaled $3.2 million for the year ended December 31, 1996, an
increase of $1.1 million, or 55.0%. This increase was primarily attributable to
a higher average outstanding balance in 1996 and higher effective yields on
mortgage backed securities resulting from lower-than-projected prepayment speeds
on the underlying mortgages during 1996. Interest income from other investment
securities, federal funds sold, and FHLB stock increased nominally for the year
ended December 31, 1996, due to a higher average volume in 1996 as compared to
1995. Interest income on mortgage backed securities and investment securities
for the year ended December 31, 1996 were favorably impacted by the fourth
quarter, 1996 purchase of securities with cash proceeds from the December
deposit assumption.
Interest Expense
Interest expense for the year ended December 31, 1996 was $14.3
million, compared to $14.2 million for the year ended December 31, 1995, a $.1
million or 0.8% increase. This increase was due to a higher average balance of
savings deposits in 1996, partially offset by lower rates paid on deposit
accounts and borrowings. As compared to 1995, interest expense on deposits in
1996 increased $.5 million due to
10
<PAGE>
higher average outstanding balances and declined $.1 million due to lower rates
paid on deposit accounts. The Company's cost of deposits declined to a weighted
average rate of 4.88% in 1996 from 4.99% in 1995. The Company's cost of
certificate of deposit accounts declined 11 basis points to a weighted average
rate of 5.58% in 1996 from 5.69% in 1995, due to the maturity and renewal, at
generally lower market rates, of a large portion of the Company's certificate of
deposit accounts outstanding at December 31, 1995. Interest expense on FHLB
advances and other borrowings declined $.2 million, or 6.7%, due to lower
outstanding balances and reduced borrowing rates in 1996.
Provision for Loan Losses
The Company establishes provisions for loan losses, which are charged
to operations, in order to maintain the allowance for loan losses at a level
which is deemed to be appropriate based upon an assessment of prior loss
experience, the volume and type of lending presently conducted by the Company,
industry standards, past due loans, economic conditions in the Company's market
area generally and other factors related to the collectibility of the Company's
loan portfolio. For the year ended December 31, 1996, the provision for loan
losses amounted to $28,000, a decrease of $635,000 compared to 1995. The decline
in the provision in 1996 was due to improved credit quality as reflected in
lower levels of nonperforming and classified assets. The Company substantially
increased the amount of its reserves in 1995 based upon an evaluation of loan
assets, the change in the composition of the loan portfolio during 1995,
information received from the OTS following a regulatory examination, and
management's decision to significantly increase the reserve against potential
losses in a weak economic environment. Nonperforming assets declined to .59% of
gross loans receivable at December 31, 1996 compared to 1.39% at December 31,
1995.
Noninterest Income
Total noninterest income increased by $368,000, or 64.2%, to $941,000
for the year ended December 31, 1996 compared to 1995. This increase was
primarily attributable to increased mortgage servicing income, higher service
charge income due to a larger customer base and increased number of deposit
accounts, and a net gain on sales of investment securities. These increases were
partially offset by a decline in commission income from annuity sales, from
$464,000 in 1995 to $138,000 in 1996. The Company has implemented a strategic
business plan intended to increase 1997 annuity sales, and has hired new
management experienced in the brokerage industry to oversee these operations.
There can be no assurance, however, that such sales will increase as intended.
General and Administrative Expense
Total general and administrative expenses were $9.1 million for the
year ended December 31, 1996, an increase of approximately $2.0 million, or
27.3%, over the $7.1 million recorded for the year ended December 31, 1995.
Included in general and administrative expense for 1996 was a non-recurring SAIF
special insurance premium assessment of $1.4 million. Excluding the special
assessment, general and administrative expense would have been $7.7 million for
the year ended December 31, 1996. The increases in 1996 were primarily
attributable to higher compensation and employee benefits, data processing
costs, legal and professional fees, and costs associated with the Company's
expansion of its branch locations and product lines.
Income Tax Expense
Total income tax expense was $623,000 for the year ended December 31,
1996 compared to $414,000 for the comparable period in 1995. This represents an
increase of $209,000 or 50.5%. The increase was due to the increase in taxable
income in 1996 as compared to 1995. The effective tax rate for the year ended
December 31, 1996 was 42.3%, compared to 38.1% for the year ended December 31,
1995.
11
<PAGE>
Comparison of Financial Condition at December 31, 1996 and December 31, 1995
Total assets at December 31, 1996 were $425.8 million compared to
$329.8 million at December 31, 1995, a $96.0 million or 29.1% increase. Asset
growth reflected the Company's assumption of $102.0 million of deposit
liabilities from Fremont Investment and Loan on December 6, 1996, and the
subsequent reinvestment of the related cash proceeds into the Company's
available for sale securities portfolio. Securities available for sale increased
by $83.2 million to $166.6 million at December 31, 1996, due to the investment
of the cash proceeds from the Fremont transaction, partially offset by the sale,
during 1996, of $8.5 million of mortgage backed securities. Total loans
receivable held for investment were $233.2 million at December 31, 1996,
compared to $228.4 million at December 31, 1995, reflecting increases in
outstanding balances of one-to four-family loans and multi-family, commercial
real estate, and land and improvement loans. Loans held for sale were $130,000
at December 31, 1996, compared to $92,000 at December 31, 1995. Currently, the
Company is selling loans only on an individual basis to the Federal Home Loan
Mortgage Corporation.
Total liabilities at December 31, 1996 were $380.0 million compared to
$282.2 million at December 31, 1995, a $97.8 million, or 34.7% increase. The
Company's deposits totaled $318.1 million at December 31, 1996, compared to
$215.3 million at December 31, 1995, an increase of $102.9 million primarily due
to the assumption of deposit liabilities in December, 1996. Borrowings declined
to $59.8 million at December 31, 1996, from $63.9 million at December 31, 1995.
At December 31, 1996, stockholders' equity was $45.8 million, compared
to $47.6 million at December 31, 1995. Equity was reduced by $1.8 million during
1996, primarily due to repurchases of the Company's outstanding common stock.
During the third quarter of 1996, the Company paid a cash dividend of $.05 per
share on its outstanding common stock, reducing stockholders' equity by
$165,000. Unrealized losses on securities available for sale at December 31,
1996, compared to unrealized gains at December 31, 1995, resulted in a decrease
of $.6 million in equity.
Comparison of Operating Results for the Years Ended December 31, 1995 and
December 31, 1994
General
Net income for the year ended December 31, 1995 was $673,000, a
reduction of $575,000, or 46.1%, from the $1,248,000 in net income for the year
ended December 31, 1994. The operating results of the Company during the year
ended December 31, 1995 were impacted by substantial earning asset growth
resulting from the Conversion, a significant increase in the cost of deposits, a
reduction in noninterest income due to net losses on the sales of securities and
lower mortgage loan servicing fees, and an increase in general and
administrative expenses primarily due to the costs of becoming a publicly-held
entity, increases in occupancy and computer expenses, and increases in employee
compensation. In addition, the Company added substantially to loan loss reserves
during 1995. Increases in the Company's cost of deposits, from 3.85% in 1994 to
4.99% in 1995, reduced the Company's net interest margin from 2.96% for the year
ended December 31, 1994 to 2.65% for the year ended December 31, 1995.
The operating results of the Company during the years ended December
31, 1995 and 1994 were also influenced by the February 1993 acquisition of three
branches from the RTC. The acquisition was comprised of deposits totaling
approximately $95.3 million and an approximately equivalent amount of cash. The
cash was reinvested in various mortgage backed securities and other investments.
The addition of the three branches also significantly increased general and
administrative expenses for the years ended December 31, 1995 and 1994.
12
<PAGE>
Interest Income
Interest income for the year ended December 31, 1995 increased by $4.8
million, or 27.1%, to $22.5 million compared to $17.7 million for the year ended
December 31, 1994. Interest income from loans, which accounted for 79.1% of
total interest income for the year ended December 31, 1995, increased by $2.8
million, or 18.9%, due to a $20.4 million, or 9.2%, increase in the average
balance of loans and the upward repricing of a portion of the Company's
adjustable rate mortgage loans during 1995. Interest income on mortgage backed
securities totaled $2.1 million for the year ended December 31, 1995, an
increase of $875,000, or 72.6%. This increase was primarily attributable to the
sale of approximately $13.7 million of low-yielding mortgage backed securities,
followed by purchases of $43.1 million of higher yielding mortgage backed
securities during 1995. Interest income from other investment securities,
federal funds sold, and FHLB stock increased by $1.1 million, or 73.1%, due to
volume and rate increases during 1995.
Interest Expense
Interest expense for the year ended December 31, 1995 was $14.2 million
compared to $9.8 million for the year ended December 31, 1994, a $4.4 million or
44.6% increase. This increase was due to higher rates paid on deposit accounts
and an increase in FHLB advances and other borrowings. Interest expense on
deposits increased $2.6 million, or 33.3%, during 1995 due to higher rates paid
on certificate of deposit accounts. The Company's cost of deposits rose 114
basis points to a weighted average rate of 4.99% in 1995 from 3.85% in 1994. The
Company's cost of certificate of deposit accounts increased 129 basis points to
a weighted average rate of 5.69% in 1995 from 4.40% in 1994. As market interest
rates stabilized and declined slightly during 1995 following a year of rapid
increases, the Company's average cost of deposits continued to rise as long-term
certificate of deposit accounts, opened during a period of lower market interest
rates, matured and were renewed at higher rates. Interest expense on FHLB
advances and other borrowings increased $1.7 million, or 92.1%. Of that amount,
$1.2 million was due to increases in borrowings to fund the purchase of mortgage
backed securities. The remainder of the increase was due to higher rates on
borrowings in 1995.
Provision for Loan Losses
For the year ended December 31, 1995, the provision for loan losses
amounted to $663,000, an increase of $242,000 over 1994. The Company increased
the amount of its reserves in 1995 based upon an evaluation of loan assets,
including a review of mortgage loans which are paid current but upon which
property taxes are delinquent greater than two years. The increased provision in
1995 also reflected, in part, the change in the composition of the loan
portfolio for the year ended December 31, 1995 compared to the year ended
December 31, 1994, information received from the OTS following a regulatory
examination, and management's decision to continue to increase the reserve
against potential losses in a weak economic environment. Loans held for
investment at December 31, 1995 totaled $228.4 million, approximately unchanged
from $227.4 million at December 31, 1994. Nonperforming assets increased to
1.39% of gross loans receivable at December 31, 1995 compared to .29% at
December 31, 1994, partially due to the decision of management to place on
nonaccrual status $1.7 million of loans which were performing in accordance with
their contractual terms but were identified as having significant risk
characteristics.
Noninterest Income
Total noninterest income decreased $475,000, or 45.3%, to $573,000 for
the year ended December 31, 1995 compared to 1994. This decrease was primarily
attributable to losses of $250,000 from the sale of mortgage backed and
investment securities during 1995, the proceeds of which were used to purchase
higher yielding mortgage backed securities. Mortgage loan servicing fee income
declined in 1995, due to
13
<PAGE>
the negative impact of a guaranteed yield maintenance agreement on loans
serviced for another financial institution. The agreement expired in 1996.
General and Administrative Expense
Total general and administrative expense was $7.1 million for the year
ended December 31, 1995, an increase of approximately $800,000, or 12.7%, over
the $6.3 million recorded for the year ended December 31, 1994. Total
compensation and employee benefits increased $328,000, or 11.1%, primarily due
to expenses related to stock benefit plans including the ESOP, a Recognition and
Retention Plan for Outside Directors, and a Performance Equity Program for
Officers. The purpose of the stock benefit plans is to provide Directors and
employees of the Company with a proprietary interest in the Company in a manner
designed to encourage such persons to remain with the Company. Occupancy and
equipment expenses increased by $66,000, or 7.7%, to $920,000, as the result of
higher depreciation expenses related to the remodeling of branch offices and
general upgrades of computer hardware and software. In 1995, the Company
experienced expense increases related to becoming a publicly held entity,
including higher accounting and legal expenses and $85,000 in Delaware franchise
taxes.
Income Tax Expense
Total income tax expense was $414,000 for the year ended December 31,
1995 compared to $949,000 for the comparable period in 1994. This represents a
decline of $535,000 or 56.4%. This decline was due to the decrease in taxable
income in 1995 as compared to 1994. The effective tax rate for the year ended
December 31, 1995 was 38.1%, compared to 43.2% for the year ended December 31,
1994.
Comparison of Financial Condition at December 31, 1995 and December 31, 1994
Total assets at December 31, 1995 were $329.8 million compared to
$298.3 million at December 31, 1994, a $31.5 million or 10.6% increase. Asset
growth reflected an increase in the Company's securities available for sale,
which grew by $50.2 million, or 151.0%, to $83.4 million at December 31, 1995.
This increase was due to the investment of $12.0 million of the cash proceeds
from the stock conversion into a combination of short to medium term treasury
notes and mortgage backed securities, and a decision by management to leverage
the balance sheet through the purchase of investment securities and mortgage
backed securities funded by reverse repurchase agreements and other
collateralized borrowings. In addition, the Company securitized and exchanged
for mortgage backed securities $15.0 million of 15-year fixed rate mortgage
loans. Total loans receivable held for investment were $228.4 million at
December 31, 1995, essentially unchanged from $227.4 million at December 31,
1994. Loans held for sale were $92,000 at December 31, 1995, compared to $16.1
million at December 31, 1994. During the year ended December 31, 1995, the
Company sold $18.5 million of loans that it originated in 1994 and 1995. As of
December 31, 1995, the Company had fulfilled an obligation to sell loans and was
only designating a small number of its newly originated loans as held for sale.
At December 31, 1995, the Company was selling loans only on an individual basis
to the Federal Home Loan Mortgage Corporation.
Total liabilities at December 31, 1995 were $282.2 million compared to
$275.0 million at December 31, 1994, a $7.2 million, or 26.2% increase. The
increase in liabilities was primarily attributable to an increase in borrowings,
to $63.9 million at December 31, 1995 from $59.8 million at December 31, 1994,
to fund purchases of mortgage backed and investment securities. During the year
ended December 31, 1995, savings deposits increased to $215.3 million from
$214.3 million at December 31, 1994.
Equity increased to $47.6 million at December 31, 1995 from $23.2
million at December 31, 1994. The increase was primarily due to the proceeds of
$24.7 million from the issuance of common stock on February 15, 1995, partially
offset by the repurchase of $2.2 million of treasury stock in December 1995.
Equity increased due to net income of $673,000 and net unrealized gains on
securities available for sale of $169,000.
14
<PAGE>
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, principal and
interest payments on loans, FHLB advances and, to a lesser extent, proceeds from
the sale of loans. While maturities and scheduled amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions, and competition. The
Bank maintains the required minimum levels of liquid assets as defined by OTS
regulations. This requirement, which may be varied at the direction of the OTS
depending upon economic conditions and deposit flows, is based upon a percentage
of deposits and short-term borrowings. The required ratio is currently 5%. The
Bank's average liquidity ratios were 7.7%, 6.1%, and 5.9% for the years ended
December 31, 1996, 1995 and 1994, respectively. Management attempts to maintain
a liquidity ratio as close to the minimum as possible, which reflects its
strategy to invest excess liquidity in higher yielding interest earning assets
such as loans. At December 31, 1996, the Bank exceeded all of its regulatory
capital requirements with a tangible capital level of $34.4 million, or 8.28% of
total adjusted assets, which was above the required level of $6.2 million or
1.5%; core capital of $34.8 million, or 8.36% of total adjusted assets, which
was above the required level of $12.5 million or 3.00%, and risk-based capital
of $36.1 million, or 19.22% of risk-weighted assets, which was above the
required level of $15.0 million or 8.00%.
Cash flows provided by (used in) operating activities were $24,000,
$12.0 million, and ($14.4) million for the years 1996, 1995 and 1994,
respectively. Net cash used for investing activities consisted primarily of loan
originations and purchases of mortgage backed securities and other investment
securities, offset by principal collections on loans and mortgage backed
securities and proceeds from the sales and maturities of investment securities
and mortgage backed securities. Disbursements on loans originated and purchased
(excluding loans originated for sale) were $36.0 million, $36.0 million, and
$66.8 million for the years 1996, 1995, and 1994, respectively. Principal
payments on loans receivable were $31.2 million, $26.5 million, and $29.3
million during the same periods. Purchases of mortgage backed securities and
investment securities were $122.3 million, $82.6 million, and $32.3 million,
respectively, for 1996, 1995, and 1994. The increase in 1996 was related to
investment purchases made in conjunction with the assumption of deposit
liabilities in December, 1996. Proceeds from sales of investment securities were
$3.2 million, $16.1 million, and $5.2 million, respectively, for the years ended
1996, 1995, and 1994. Proceeds from maturities of investment securities were
$14.9 million and $11.9 million, respectively, in 1996 and 1995. The Company had
no maturities of investment securities in 1994. Proceeds from sales of mortgage
backed securities were $8.4 million, $13.7 million, and $29.0 million, while
cash provided by principal paydowns on mortgage backed securities were $11.8
million, $6.2 million and $3.7 million, for the years ended 1996, 1995, and
1994, respectively.
In 1996, cash provided by financing activities consisted primarily of
cash proceeds of $98.4 million received in connection with the assumption of
deposit liabilities, net of core deposit premium. In 1995, the Company received
cash of $24.7 million in proceeds from the sale of common stock. In 1996, cash
used in financing activities included the repayment of $4.4 million of reverse
repurchase agreements and purchases of treasury stock totaling $2.2 million. The
net increase (decrease) in deposits, excluding purchased deposits, was $1.0
million, $1.0 million, and ($4.0 million) for the years 1996, 1995 and 1994,
respectively.
The Company's most liquid assets are cash and short-term investments.
The levels of these assets are dependent on the Company's operating, financing,
lending and investing activities during any given period. At December 31, 1996,
cash and short-term investments totaled $5.0 million.
The Company has other sources of liquidity if a need for additional
funds arises, including FHLB advances through the Bank. At December 31, 1996,
the Company had $46.8 million in advances outstanding and $13.0 million of
reverse repurchase agreements with the FHLB. Other sources of liquidity include
investment securities maturing within one year.
15
<PAGE>
At December 31, 1996, the Company had outstanding loan commitments of
$2.7 million. The Company anticipates that it will have sufficient funds
available to meet its current loan origination commitments. Certificates of
deposit which are scheduled to mature in one year or less from December 31, 1996
totaled $187.9 million.
Impact of Inflation
The Consolidated Financial Statements and Notes thereto presented
herein have been prepared in accordance with GAAP, which require the measurement
of financial position and operating results in terms of historical dollar
amounts without considering the changes in the relative purchasing power of
money over time due to inflation. The impact of inflation is reflected in the
increased cost of the Company's operations. Unlike industrial companies, nearly
all of the assets and liabilities of the Company are monetary in nature. As a
result, interest rates have a greater impact on the Company's performance than
do the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or to the same extent as the price of goods and
services.
Impact of New Accounting Standards
Statement of Financial Accounting Standards No. 114 ("SFAS 114"),
"Accounting by Creditors for Impairment of a Loan," as amended by Statement of
Financial Accounting Standards No. 118 ("SFAS 118"), "Accounting by Creditors
for Impairment of a Loan - Income Recognition and Disclosures," was effective
January 1, 1995. Under SFAS 114, a loan is impaired when it is probable that a
creditor will be unable to collect all amounts due (i.e., both principal and
interest) according to the contractual terms of the loan agreement. SFAS 114
excludes, among other items, large groups of smaller balance homogenous loans
that are collectively evaluated for impairment. If the measure of the impaired
loan is less than the recorded investment in the loan, a creditor shall
recognize an impairment by recording a valuation allowance with a corresponding
charge to bad debt expense. SFAS 118 eliminates the income recognition
provisions included in SFAS 114, thereby permitting the use of existing methods
for recognizing interest income on impaired loans. The Company adopted the
provisions of SFAS 114 and SFAS 118 effective January 1, 1995.
In November 1993, the American Institute of Certified Public
Accountants issued SOP 93-6, "Employers' Accounting for Employee Stock Ownership
Plans" which is effective for fiscal years beginning after December 15, 1993.
The Company began applying SOP 93-6 during its fiscal year beginning July 1,
1994. SOP 93-6 requires the application of its guidance for shares acquired by
ESOPs after December 31, 1992, but not yet committed to be released as of the
beginning of the year SOP 93-6 is adopted. Among other things, SOP 93-6 changed
the measure of compensation expense recorded by employers for leveraged ESOPs
from the cost of ESOP shares to the fair value of ESOP shares. Under SOP 93-6,
the Company recognizes compensation cost equal to the fair value of the ESOP
shares during the periods in which they become committed to be released. To the
extent that the fair value of the Company's ESOP shares differ from the cost of
such shares, this differential is charged or credited to equity. Employers with
internally leveraged ESOPs such as the Company will not report the loan
receivable from the ESOP as an asset and will not report the ESOP debt from the
employer as a liability. See "Management of the Company Benefits - Employee
Stock Ownership Plan and Trust."
Effective December 1995, the Company adopted Statement of Financial
Accounting Standards No. 122 ("SFAS 122"), "Accounting for Mortgage Servicing
Rights." SFAS 122 allows financial institutions that originate mortgages and
sell them into the secondary market to recognize the retained right to service
the loans. This rule amends SFAS 65, which permitted only purchased mortgage
servicing rights to be recognized as an asset. SFAS 122 makes no distinction
between purchased and originated mortgage servicing rights. During 1996, the
Company sold $2.6 million of loans in the secondary market and recorded $21,000
of originated mortgage servicing rights on those loans.
16
<PAGE>
In October 1995, the FASB issued Statement of Financial Standards No.
123 ("SFAS 123"), "Accounting for Stock Based Compensation," which established
accounting and disclosure requirements using a fair value based method of
accounting for stock based employee compensation plans. Under SFAS 123,
beginning in 1996 the Company had the option to either adopt the new fair value
based accounting method or continue the intrinsic value based method and provide
pro forma net income and earnings per share as if the accounting provisions of
SFAS 123 had been adopted. The Company has adopted only the disclosure
requirements of SFAS 123, and applies Accounting Principles Board Opinion (APB)
No. 25, "Accounting for Stock Issued to Employees," in accounting for its stock
options.
In June 1996, SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," was issued. This statement
establishes standards for when transfers of financial assets, including those
with continuing involvement by the transferor, should be considered a sale. SFAS
No. 125 also establishes standards for when a liability should be considered
extinguished. In December 1996, the Financial Accounting Standards Board issued
SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB
Statement No. 125." SFAS No. 127 reconsiders certain provisions of SFAS 125 and
defers for one year the effective date of implementation for transactions
related to repurchase agreements, dollar-roll repurchase agreements, securities
lending, and similar transactions. This statement is effective for transfers of
assets and extinguishments of liabilities occurring after December 31, 1996,
applied prospectively. Earlier adoption or retroactive application of these
statements is not permitted. SFAS Nos. 125 and 127 are not expected to have a
material effect on the Bank's financial statements.
Long-lived assets and certain identifiable intangibles to be held and
used are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of assets may not be recoverable.
Determination of recoverability is based on an estimate of undiscounted future
cash flows resulting from the use of the asset and its eventual disposition.
Measurement of an impairment loss for long-lived assets and identifiable
intangibles that management expects to hold and use are based on the fair value
of the asset. Long-lived assets and certain identifiable intangibles to be
disposed of are reported at the lower of carrying amount or fair value less cost
to sell.
17
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Monterey Bay Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition
of Monterey Bay Bancorp, Inc. and subsidiary (the "Company") as of December 31,
1996 and 1995, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of Monterey Bay Bancorp,
Inc. and subsidiary at December 31, 1996 and 1995, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche, LLP
February 28, 1997
_______________
Deloitte Touche
Tohmatsu
International
_______________
<PAGE>
San Francisco, California
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1996 AND 1995 (Dollars in thousands, except per share amounts)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31,
-----------------------------
1996 1995
<S> <C>
ASSETS
Cash and due from depository institutions $ 4,447 $ 4,217
Overnight deposits 531 -
-------- --------
Total cash and cash equivalents 4,978 4,217
Certificates of deposit 199 782
Loans held for sale, at market (Note 4) 130 92
Securities available for sale:
Mortgage backed securities (amortized cost, 1996, $117,094; 1995, $52,004) (Note 2) 116,610 52,417
Investment securities (amortized cost, 1996, $50,322; 1995, $31,110) (Note 3) 49,955 30,990
Securities held to maturity:
Mortgage backed securities (market value, 1996, $169; 1995, $199) (Note 2) 173 205
Investment securities (market value, 1996, $403; 1995, $797) (Note 3) 404 790
Loans receivable held for investment (net of allowance for loan losses, 1996, $1,311;
1995, $1,362) (Note 4) 233,208 228,387
Federal Home Loan Bank stock, at cost (Note 6) 5,040 2,542
Premises and equipment, net (Note 7) 4,887 4,030
Accrued interest receivable (Note 5) 2,556 2,109
Core deposit intangibles, net 3,979 651
Other assets 3,643 2,556
-------- --------
TOTAL $425,762 $329,768
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Savings deposits (Note 8) $318,145 $215,284
Federal Home Loan Bank advances (Note 9) 46,807 46,520
Securities sold under agreements to repurchase (Note 10) 13,000 17,361
Accounts payable and other liabilities 2,051 2,999
-------- --------
Total liabilities 380,003 282,164
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 15)
STOCKHOLDERS' EQUITY (Note 12):
Preferred stock, $.01 par value, 2,000,000 shares authorized and unissued - -
Common stock, $.01 par value, 9,000,000 shares authorized;
3,593,750 shares issued and outstanding at December 31, 1996 and 1995 36 36
Additional paid-in capital 27,114 27,037
Unearned shares held by employee stock ownership plan (1,840) (2,070)
Treasury stock, 350,387 and 179,687 shares at December 31, 1996 and 1995,
respectively (4,374) (2,201)
Retained earnings, substantially restricted 25,320 24,633
Unrealized gain (loss) on securities available for sale, net of taxes (497) 169
-------- --------
Total stockholders' equity 45,759 47,604
-------- --------
TOTAL $425,762 $329,768
======== ========
</TABLE>
See notes to consolidated financial statements.
19
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- --------------------------------------------------------------------------------
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1996 1995 1994
<S> <C>
INTEREST INCOME:
Loans receivable $18,015 $17,826 $14,998
Mortgage backed securities 3,224 2,080 1,205
Other investment securities 2,747 2,638 1,524
----------- ------------ ------------
Total interest income 23,986 22,544 17,727
----------- ------------ ------------
INTEREST EXPENSE:
Savings deposits 10,949 10,602 7,954
FHLB advances and other borrowings 3,384 3,625 1,887
----------- ------------ ------------
Total interest expense 14,333 14,227 9,841
----------- ------------ ------------
NET INTEREST INCOME BEFORE PROVISION
FOR LOAN LOSSES 9,653 8,317 7,886
PROVISION FOR LOAN LOSSES 28 663 421
----------- ------------ ------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 9,625 7,654 7,465
----------- ------------ ------------
NONINTEREST INCOME:
Gain (loss) on sale of mortgage backed
and investment securities, net 168 (250) (110)
Commissions from annuity sales 138 464 479
Customer service charges 403 315 237
Other income 232 44 442
------------ ------------ ------------
Total 941 573 1,048
------------ ------------ ------------
GENERAL AND ADMINISTRATIVE EXPENSE:
Compensation and employee benefits 3,372 3,280 2,952
Occupancy and equipment 914 920 854
Deposit insurance premiums 532 516 488
SAIF recapitalization assessment 1,387 - -
Data processing fees 495 428 376
Stationery, telephone and office expenses 353 333 300
Advertising and promotion 194 181 265
Amortization of core deposit premiums 340 304 304
Other 1,504 1,178 777
------------ ------------ ------------
Total 9,091 7,140 6,316
------------ ------------ ------------
INCOME BEFORE INCOME TAX EXPENSE 1,475 1,087 2,197
INCOME TAX EXPENSE (Note 11) 623 414 949
------------ ------------ ------------
NET INCOME $ 852 $ 673 $ 1,248
============ ============ ============
NET INCOME PER SHARE (1) $ 0.27 $ 0.17 $ N/A
============ ============ ============
</TABLE>
(1) The 1995 earnings per share computation is based on net income from
February 14, 1995, the date Monterey Bay Bank (formerly Watsonville
Federal Savings and Loan Association) converted to a federally chartered
stock association and Monterey Bay Bancorp, Inc. became the holding
company for the Bank.
See notes to consolidated financial statements.
20
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1996,
1995 AND 1994 (Amounts in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Unrealized Gain
(Loss)
on Securities
Common Stock(1) Available for
------------------------- Paid-In Acquired Treasury Retained Sale (Net of
Shares Amount Capital by ESOP Stock Earnings Taxes) Total
------ ------ ------- -------- -------- -------- ---------------- -----
<S> <C>
Balance at
January 1, 1994: $22,712 $ 361 $23,073
Change in unrea-
lized gain (loss)
on securities
available for sale,
net of taxes (1,072) (1,072)
Net income 1,248 1,248
------- ------- -------
Balance at
December 31, 1994: 23,960 (711) 23,249
Issuance of
common stock 3,594 $36 $26,990 $(2,300) 24,726
Purchase of
treasury stock $(2,201) (2,201)
Earned ESOP shares 47 230 277
Change in unrea-
lized gain (loss)
on securities
available for sale,
net of taxes 880 880
Net income 673 673
----- --- ------- ------- ------- ------- ------- -------
Balance at
December 31, 1995: 3,594 36 27,037 (2,070) (2,201) 24,633 169 47,604
Purchase of
treasury stock (2,173) (2,173)
Dividends paid (165) (165)
Earned ESOP shares 77 230 307
Change in unrea-
lized gain (loss)
on securities
available for sale,
net of taxes (666) (666)
Net income 852 852
----- --- ------- ------- ------- ------- ------- -------
Balance at
December 31, 1996: 3,594 $36 $27,114 $(1,840) $(4,374) $25,320 $ (497) $45,759
===== === ======= ======= ======= ======= ======= =======
</TABLE>
(1) Number of shares of common stock includes 287,500 shares which are
pledged as security for a loan to the Bank's ESOP. Shares earned at
December 31, 1996 and 1995 were 57,500 and 28,750, respectively.
(2) The Company repurchased 170,700 and 179,687 share of Company common stock
during 1996 and 1995, respectively.
See notes to consolidated financial statements.
21
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (Dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------
1996 1995 1994
----------- ---------- -----------
<S> <C>
OPERATING ACTIVITIES:
Net income $ 852 $ 673 $ 1,248
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization on premises and equipment 372 362 318
Amortization of core deposit premium 340 304 304
Amortization of premiums, net of discounts 487 649 113
Loan origination fees deferred, net 138 216 346
Amortization of deferred loan fees (217) (580) (279)
Provision for loan losses 28 663 421
Compensation expense related to ESOP shares released 307 277 -
(Gain) loss on sale of mortgage backed securities and
investment securities (168) 250 110
Charge-off on loans transferred to real estate owned (78) - -
Loss on sale of fixed assets 5 - 24
Originations of loans held for sale (2,666) (9,597) (52,656)
Proceeds from sales of loans originated for sale 2,628 18,541 37,383
Change in income taxes payable and deferred income taxes (234) (309) (651)
Change in other assets (376) (911) (1,096)
Change in interest receivable (447) (568) (297)
Change in accounts payable and other liabilities (947) 2,062 267
--------- --------- ----------
Net cash provided by (used in) operating activities 24 12,032 (14,445)
--------- --------- ----------
INVESTING ACTIVITIES:
Loans originated for portfolio (36,061) (35,994) (62,793)
Principal payments on loans receivable 31,171 26,535 29,331
Purchases of loans receivable - - (3,988)
Purchases of mortgage backed securities held to maturity - (69) -
Purchases of mortgage backed securities available for sale (85,467) (43,022) (15,216)
Proceeds from sales of investment securities available for sale 3,194 16,071 5,176
Proceeds from sales of mortgage backed securities available for sale 8,427 13,746 29,016
Principal paydowns on mortgage backed securities 11,776 6,240 3,742
Purchases of investment securities held to maturity - (766) (195)
Purchases of investment securities available for sale (36,833) (38,714) (16,871)
Proceeds from maturities of investment securities 14,900 11,900 -
Purchases of premises and equipment, net (1,235) (129) (831)
Decreases in certificates of deposit 581 687 1,478
(Purchases) redemptions of FHLB stock (2,498) 572 (1,960)
Other - 78 4
--------- --------- ----------
Net cash used in investing activities (92,045) (42,865) (33,107)
--------- --------- ----------
</TABLE>
22
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (Dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------
1996 1995 1994
----------- ---------- -----------
<S> <C>
FINANCING ACTIVITIES:
Net increase (decrease) in savings deposits $ 798 $ 974 $ (4,032)
Assumption of savings deposits, net of core deposit premiums (Note 8) 98,395 - -
Proceeds (repayments) on Federal Home Loan Bank advances, net 287 (13,262) 49,782
(Repayments) proceeds on reverse repurchase agreements, net (4,360) 17,361 -
Proceeds from the sale of common stock - 24,726 -
Cash dividends (165) - -
Purchases of treasury stock (2,173) (2,201) -
---------- --------- ---------
Net cash provided by financing activities 92,782 27,598 45,750
---------- --------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 761 (3,235) (1,802)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,217 7,452 9,254
---------- ---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,978 $ 4,217 $ 7,452
========= ======== ========
CASH PAID DURING THE PERIOD FOR:
Interest on savings deposits and advances $ 14,425 $ 13,654 $ 9,796
Income taxes 954 752 1,002
NONCASH INVESTING ACTIVITIES:
Loans transferred to held for investment, at market value - 7,385 58,009
Mortgage backed securities acquired in exchange for securitized
loans, net of deferred fees - 15,044 -
Mortgage backed securities transferred from held to maturity to
available for sale, net - 15,025 -
Investment securities transferred to held to maturity - - 200
Transfer of loans to real estate owned 369 297 -
Loans to facilitate the sale of real estate owned - 181 -
</TABLE>
See notes to consolidated financial statements.
23
<PAGE>
MONTEREY BAY BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies of Monterey Bay Bancorp, Inc. (the
"Company") are as follows:
Basis of Consolidation - The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiary, Monterey
Bay Bank (the "Bank," formerly Watsonville Federal Savings and Loan
Association), and the Bank's wholly owned subsidiary, Portola
Investment Corporation ("Portola"). All significant intercompany
transactions and balances have been eliminated in consolidation. The
Company is a Delaware corporation, organized by the Bank for the
purpose of acquiring all of the capital stock of the Bank issued upon
the 1995 conversion of the Bank from a federally chartered mutual
savings and loan association to a federally chartered stock savings and
loan association (the "Conversion"). On February 14, 1995, the Company
completed its initial public offering in connection with the Conversion
and began trading on the Nasdaq National Market under the symbol "MBBC"
on February 15, 1995. All amounts prior to the completion of the
Conversion relate to the Bank. The Company, the holding company of the
Bank, engages only in limited business operations primarily involving
investments in mortgage backed securities and other investment
securities.
Cash Equivalents - The Company considers all highly liquid investments
with an initial maturity of three months or less to be cash
equivalents. A percentage of the Company's transaction account
liabilities are subject to Federal Reserve requirements. The Company's
Federal Reserve requirement was $193,000 and $167,000, respectively, at
December 31, 1996 and 1995.
Certificates of deposit are interest bearing deposits in federally
insured financial institutions with original maturities of more than
three months.
Securities available for sale are carried at fair value. Statement of
Financial Accounting Standards No. 115 ("SFAS 115"), Accounting for
Certain Investments in Debt and Equity Securities, establishes
classification of investments into three categories: held to maturity,
trading, and available for sale. The Company identifies securities as
either held to maturity or available for sale. The Company has no
trading securities. Securities available for sale increase the
Company's portfolio management flexibility for investments and are
reported at fair value. Net unrealized gains and losses are excluded
from earnings and reported net of applicable income taxes as a separate
component of stockholders' equity until realized. Gains or losses on
sales of securities are recorded in earnings at the time of sale and
are determined by the difference between the net sales proceeds and the
cost of the security, using the specific identification method,
adjusted for any unamortized premium or discount. The adoption of SFAS
115 in 1995 resulted in the reclassification of certain securities from
the securities held for investment portfolio to the securities
available for sale portfolio.
Any permanent decline in the fair value of individual securities held
to maturity and securities available for sale below their cost would be
recognized through a write down of the investment securities to their
fair value by a charge to earnings as a realized loss.
Securities held to maturity, consisting of mortgage backed securities
and investment securities held for long-term investment, are carried at
amortized cost as the Company has the ability to hold
24
<PAGE>
these securities to maturity and because it is management's intention
to hold these securities to maturity. Premiums and discounts on
mortgage backed securities are amortized using the interest method over
the remaining period to contractual maturity, adjusted for actual and
estimated prepayments. Premiums and discounts on investment securities
are amortized and accreted into interest income on the interest method
over the period to maturity. Gains and losses on the sale of mortgage
backed securities and investment securities are determined using the
specific identification method. In limited circumstances, as specified
in the provisions of SFAS 115, the Company may transfer or sell
securities from the held to maturity portfolio.
In December 1995, the Company transferred $15.0 million of
held-to-maturity securities to the available-for-sale portfolio in
accordance with guidance from the Financial Accounting Standards Board
("FASB") on SFAS 115. The FASB allowed the reclassification of
investments in debt securities to available for sale from held to
maturity during the period November 15, 1995 through December 31, 1995
without tainting the classification of the remaining held-to-maturity
portfolio. The Securities and Exchange Commission and the banking
regulatory agencies concurred with the FASB on this issue.
Transfers of securities available for sale to securities held to
maturity portfolio are recorded at fair value. The related net
unrealized holding gains or losses, net of applicable income taxes, at
the date of transfer are reported as a separate component of
stockholders' equity and amortized over the remaining contractual life
of these securities using the interest method.
Loans Held for Sale - During the period of origination, real estate
loans are designated as either held for sale or held for investment.
Loans held for sale are carried at the lower of cost or estimated
market value, determined on an aggregate basis, and include loan
origination costs and related fees. Transfers of loans held for sale to
the held for investment portfolio are recorded at the lower of cost or
market value on the transfer date. Net unrealized losses are recognized
through an adjustment of the loan carrying values by charges to
earnings.
Loans receivable held for investment are carried at cost adjusted for
unamortized premiums and discounts and net of deferred loan origination
fees and allowance for loan losses. These loans are not adjusted to the
lower of cost or market because it is management's intention, and the
Company has the ability, to hold these loans to maturity.
Loan Origination Fees - The Company charges fees for originating loans.
These fees, net of certain related direct loan origination costs, are
deferred. The net deferred fees for loans held as investments are
recognized as an adjustment of the loan's yield over the expected life
of the loan using the interest method, which results in a constant rate
of return. When a loan is paid off or sold, the unamortized balance of
any related fees and costs is recognized as income. Other loan fees and
charges representing service costs are reported in income when
collected or earned.
Originated Mortgage Serving Rights - Effective December 1995, the
Company adopted Statement of Financial Accounting Standards No. 122
("SFAS 122"), Accounting for Mortgage Servicing Rights. SFAS 122 allows
financial institutions that originate mortgages and sell them into the
secondary market to recognize the retained right to service the loans.
This rule amends SFAS 65, which permitted only purchased mortgage
servicing rights to be recognized as an asset. SFAS 122 makes no
distinction between purchased and originated mortgage servicing rights.
During 1996, the Company sold $2.6 million of loans in the secondary
market and recorded $21,000 of
25
<PAGE>
originated mortgage servicing rights on those loans. During 1995, the
Company securitized $15.0 million of mortgage loans and recorded
$118,000 of originated mortgage servicing rights.
Sales of Loans - Gains or losses resulting from sales of loans are
recorded at the time of sale and are determined by the difference
between the net sales proceeds and the carrying value of the assets
sold. When the right to service the loans is retained, a gain or loss
is recognized based upon the net present value of expected amounts to
be received resulting from the difference between the contractual
interest rates received from the borrowers and the rate paid to the
buyer, taking into account estimated prepayments and a normal servicing
fee on such loans. The net assets resulting from the present value
computation, representing deferred expense, are amortized to operations
over the estimated remaining life of the loan using a method that
approximates the interest method. The balance of deferred premium and
expense and the amortization thereon are periodically evaluated in
relation to estimated future net servicing revenues, taking into
consideration changes in interest rates, current prepayment rates, and
expected future cash flows. The Company evaluates the carrying value of
the servicing portfolio by estimating the future net servicing income
of the portfolio based on management's best estimate of remaining loan
lives.
Interest on loans is credited to income when earned. Interest is not
recognized on loans that are considered to be uncollectible. Loans are
placed on a nonaccrual status when they become 90 days delinquent and
an allowance is established for previously accrued but uncollected
interest on such loans. Subsequent collections of delinquent interest
are recognized as interest income when received.
Impaired and Nonperforming Loans - Statement of Financial Accounting
Standards No. 114 ("SFAS 114"), Accounting by Creditors for Impairment
of a Loan, as amended by Statement of Financial Accounting Standards
No. 118 ("SFAS 118"), Accounting by Creditors for Impairment of a Loan
- Income Recognition and Disclosures, was effective January 1, 1995.
Under SFAS 114, a loan is impaired when it is probable that a creditor
will be unable to collect all amounts due (i.e., both principal and
interest) according to the contractual terms of the loan agreement.
SFAS 114 excludes, among other items, large groups of smaller balance
homogenous loans that are collectively evaluated for impairment. SFAS
118 eliminates the income recognition provisions included in SFAS 114,
thereby permitting the use of existing methods for recognizing interest
income on impaired loans.
The Company adopted the provisions of SFAS 114 and SFAS 118 effective
January 1, 1995. The adoption of SFAS 114 and SFAS 118 has not had a
significant impact on the financial position or the earnings of the
Company.
The Company has established a monitoring system for its loans in order
to identify impaired loans, potential problem loans, and to permit
periodic evaluation of the adequacy of allowances for losses in a
timely manner. Total loans include the following portfolios: (i)
residential one- to four-family loans, (ii) multi-family loans, (iii)
commercial real estate loans, (iv) construction and land loans, and (v)
non-mortgage loans. In analyzing these loans, the Company has
established specific monitoring policies and procedures suitable for
the relative risk profile and other characteristics of the loans within
the various portfolios. The Company's residential one- to four-family
and non-mortgage loans, where the aggregate loans to one borrower is
less than $500,000, are considered to be relatively homogeneous and no
single loan is individually significant in terms of its size or
potential risk of loss. Therefore, the Company generally reviews its
residential one-to four-family and non-mortgage loans, where the
aggregate loans to one borrower is less than $500,000, by
26
<PAGE>
analyzing their performance and composition of their collateral for the
portfolio as a whole. For non-homogeneous loans, including loans to one
borrower that in aggregate exceed $500,000, the Company conducts a
periodic review of each loan. The frequency and type of review is
dependent upon the inherent risk attributed to each loan, and is
directly proportionate to the adversity of the loan grade. The Company
evaluates the risk of loss and default for each loan subject to
individual monitoring.
Factors considered as part of the periodic loan review process to
determine whether a loan is impaired, as defined under SFAS 114,
address both the amount the Company believes is probable that it will
collect and the timing of such collection. As part of the Company's
loan review process the Company considers such factors as the ability
of the borrower to continue meeting the debt service requirements,
assessments of other sources of repayment, the fair value of any
collateral and the creditor's prior history in dealing with these types
of credits. In evaluating whether a loan is considered impaired,
insignificant delays (less than six months) or shortfalls (less than 5%
of the payment amount) in payment amounts, in the absence of other
facts and circumstances, would not alone lead to the conclusion that a
loan is impaired.
Any loans which meet the definition of a troubled debt restructuring,
or are partially or completely classified as Doubtful or Loss, are
considered impaired. As of December 31, 1996, the Company had $354,000
of restructured loans and $1,000 of loans which had been classified as
Doubtful or Loss. At December 31, 1995, the Company had no restructured
loans, and $1,000 of loans classified as Doubtful or Loss.
Loans on which the Company has ceased the accrual of interest
("nonaccrual loans") constitute the primary component of the portfolio
of nonperforming loans. Loans are generally placed on nonaccrual status
when the payment of interest is 90 days or more delinquent, or if the
loan is in the process of foreclosure.
When a loan is designated as impaired, the Company measures impairment
based on the fair value of the collateral of the collateral-dependent
loan. The amount by which the recorded investment of the loan exceeds
the measure of the impaired loan is recognized by recording a valuation
allowance with a corresponding charge to earnings. The Company charges
off a portion of an impaired loan against the valuation allowance when
it is probable that there is no possibility of recovering the full
amount of the impaired loan.
Payments received on impaired loans are recorded as a reduction of
principal or as interest income depending on management's assessment of
the ultimate collectibility of the loan principal. The amount of
interest income recognized is limited to the amount of interest that
would have accrued at the loans' contractual rate applied to the
recorded loan balance. Any difference is recorded as a loan loss
recovery.
Allowances for loan losses are maintained at levels that management
deems adequate to cover estimated losses and are continually reviewed
and adjusted. The Company adheres to an internal asset review system
and an established loan loss reserve methodology. Management evaluates
factors such as the prevailing and anticipated economic conditions,
historic loss experiences, composition of the loan portfolio by
property type, levels, and trends of classified loans, and loan
delinquencies in assessing overall valuation allowance levels to be
maintained. While management uses currently available information to
provide for losses on loans, additions to the allowance may be
necessary based on new information and/or future economic conditions.
27
<PAGE>
When the property collateralizing a delinquent mortgage loan is
foreclosed on by the Company and transferred to real estate owned, the
difference between the loan balance and the fair value of the property
less estimated selling costs is charged off against the allowance for
loan losses.
Premises and equipment are stated at cost, less accumulated
depreciation and amortization. The Company's policy is to depreciate
furniture and equipment on a straight-line basis over the estimated
useful lives of the various assets and to amortize leasehold
improvements over the shorter of the asset life or lease term as
follows:
Buildings 40 to 50 years
Leasehold improvements Lesser of term of lease or life of improvement
Furniture and equipment 3 to 10 years
The cost of repairs and maintenance is charged to operations as
incurred, whereas expenditures that improve or extend the service lives
of assets are capitalized.
Core deposit intangibles arise from the acquisition of deposits and are
amortized on a straight-line basis over the estimated life of the
deposit base acquired, generally seven years. The Company continually
evaluates the periods of amortization to determine whether later events
and circumstances warrant revised estimates. The carrying values of
unamortized core deposit intangibles at December 31, 1996 and 1995 were
$4.0 million and $651,000 respectively. Accumulated amortization of
core deposit intangibles at December 31, 1996 and 1995 were $1.2
million and $869,000, respectively.
Impairment of Long-Lived Assets - Long-lived assets and certain
identifiable intangibles to be held and used are reviewed for
impairment whenever events or changes in circumstances indicate that
the carrying amount of assets may not be recoverable. Determination of
recoverability is based on an estimate of undiscounted future cash
flows resulting from the use of the asset and its eventual disposition.
Measurement of an impairment loss for long-lived assets and
identifiable intangibles that management expects to hold and use are
based on the fair value of the asset. Long-lived assets and certain
identifiable intangibles to be disposed of are reported at the lower of
carrying amount or fair value less cost to sell.
Stock Based Compensation - The Company accounts for stock based awards
to employees using the intrinsic value method in accordance with
Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock
Issued to Employees."
Income Taxes - The Company accounts for income taxes in accordance with
the provisions of Statement of Financial Accounting Standards No. 109
("SFAS 109"), Accounting for Income Taxes. Under the asset and
liability method prescribed by SFAS 109, deferred tax assets and
liabilities are recognized using currently applicable tax rates for the
future tax consequences of differences between the financial statement
carrying amounts of existing assets and liabilities and their
respective tax bases. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in the period that includes the
enactment date. Future tax benefits attributable to temporary
differences are recognized to the extent the realization of such
benefits is more likely than not.
28
<PAGE>
Commissions from annuity sales arise from Portola's sale of tax
deferred annuities. Income is based on a percentage of sales which
varies based on the annuity sold and is recognized as income upon
receipt.
Earnings per share is based on the weighted average number of shares
outstanding, adjusted for the unearned shares of the employee stock
ownership plan. On February 14, 1995, the Company issued 3,593,750
shares in connection with the formation of a holding company and the
Bank's Conversion. Common shares outstanding included 287,500 shares
purchased by the Bank's employee stock ownership plan ("ESOP"). Since
the Conversion, the Company has repurchased 350,387 shares, or
approximately ten percent of the Company's outstanding shares. Net
income and common shares outstanding for the period from February 15,
1995 to December 31, 1995 were used to compute earnings per share for
the year ended December 31, 1995. For the years ending December 31,
1996 and 1995, the Company had 3,123,481 and 3,565,197, respectively,
of weighted average shares outstanding. The Company's fully diluted
earnings per share does not differ materially from its primary earnings
per share, therefore it has not been separately reported.
Recently Issued Accounting Pronouncements - In June 1996, SFAS No. 125,
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, was issued. This statement establishes
standards for when transfers of financial assets, including those with
continuing involvement by the transferor, should be considered a sale.
SFAS No. 125 also establishes standards for when a liability should be
considered extinguished. In December 1996, the Financial Accounting
Standards Board issued SFAS No. 127, Deferral of the Effective Date of
Certain Provisions of FASB Statement No. 125. SFAS No. 127 reconsiders
certain provisions of SFAS 125 and defers for one year the effective
date of implementation for transactions related to repurchase
agreements, dollar-roll repurchase agreements, securities lending, and
similar transactions. This statement is effective for transfers of
assets and extinguishments of liabilities occurring after December 31,
1996, applied prospectively. Earlier adoption or retroactive
application of these statements is not permitted. SFAS Nos. 125 and 127
are not expected to have a material effect on the Bank's financial
statements.
Use of Estimates in the Preparation of Financial Statements - The
preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
Reclassifications - Certain amounts in the 1994 consolidated financial
statements have been reclassified to conform with the 1995 and 1996
presentation.
29
<PAGE>
2. MORTGAGE BACKED SECURITIES
Mortgage backed securities available for sale and held to maturity as
of December 31, 1996 and 1995 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
December 31, 1996
------------------------------------------------------------------
Gross Gross Weighted
Amortized Unrealized Unrealized Fair Average
Cost Gains Losses Value Yield
<S> <C>
Available for sale:
FHLMC certificates $ 39,110 $ 87 $ (209) $ 38,988 7.41%
FNMA certificates 46,410 206 (395) 46,221 7.68%
GNMA certificates 15,786 - (90) 15,696 7.62%
CMO/REMIC tranches 15,788 - (83) 15,705 6.74%
--------- --------- -------- ---------
Total $ 117,094 $ 293 $ (777) $ 116,610 7.46%
========= ========= ======== =========
Held to maturity:
FNMA certificates $ 173 $ - $ (4) $ 169 5.12%
========= ========= ======== =========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1995
------------------------------------------------------------------
Gross Gross Weighted
Amortized Unrealized Unrealized Fair Average
Cost Gains Losses Value Yield
<S> <C>
Available for sale:
FHLMC certificates $ 27,984 $ 266 $ (63) $ 28,187 6.65%
FNMA certificates 24,020 210 - 24,230 6.99%
-------- ------- -------- --------
Total $ 52,004 $ 476 $ (63) $ 52,417 6.81%
======== ======= ======== ========
Held to maturity:
FNMA certificates $ 205 $ - $ (6) $ 199 5.22%
======== ======= ======== ========
</TABLE>
30
<PAGE>
The amortized cost and fair value of mortgage backed securities by
contractual maturity are shown below (dollars in thousands). Actual
maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
--------------------------------- ---------------------------------
Weighted Weighted
Amortized Fair Average Amortized Fair Average
Cost Value Yield Cost Value Yield
<S> <C>
Mortgage backed securities
available for sale - due
in 5 years or less $ 1,909 $ 1,908 7.34% $ 4,891 $ 4,927 7.35%
Mortgage backed securities
securities available for
sale - due after 10 years 115,185 114,702 7.46% 47,113 47,490 6.50%
-------- -------- -------- --------
Total mortgage backed
securities available for
sale $117,094 $116,610 7.46% $ 52,004 $ 52,417 6.81%
======== ======== ======== ========
Mortgage backed securities
held to maturity - due
in 5 years or less $ 173 $ 169 5.12% $ 205 $ 199 5.22%
======== ======== ======== ========
</TABLE>
Sales of mortgage backed securities available for sale are summarized
as follows (dollars in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------
1996 1995 1994
<S> <C>
Proceeds from sales $ 8,427 $ 13,746 $ 29,016
Gross realized gains on sales 87 - 36
Gross realized losses on sales 17 258 212
</TABLE>
31
<PAGE>
3. INVESTMENT SECURITIES
Investment securities available for sale and held to maturity at
December 31, 1996 and 1995 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
December 31, 1996
------------------------------------------------------------------
Gross Gross Weighted
Amortized Unrealized Unrealized Fair Average
Cost Gains Losses Value Yield
<S> <C>
Available for sale:
U.S. government securities:
U.S. Treasury notes $ 2,003 $ - $ (7) $ 1,996 5.28%
FHLB Debentures 22,000 3 (97) 21,906 6.99%
FHLMC Debentures 8,307 10 (61) 8,256 6.86%
FNMA bond 1,001 3 - 1,004 6.57%
SLMA bond 2,011 - (17) 1,994 5.60%
Other securities:
Smith Breeden short-term
government securities fund 15,000 - (201) 14,799 5.19%
-------- -------- ------- --------
Total $ 50,322 $ 16 $ (383) $ 49,955 6.30%
======== ======== ======= ========
Held to maturity:
U. S. government securities:
U.S. Treasury notes $ 153 $ - $ (1) $ 152 5.18%
Other securities:
Tennessee Valley bond 144 - - 144 5.29%
FICO zero coupon bond 107 - - 107 5.00%
-------- -------- ------- --------
Total $ 404 $ - $ (1) $ 403 5.17%
======== ======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1995
------------------------------------------------------------------
Gross Gross Weighted
Amortized Unrealized Unrealized Fair Average
Cost Gains Losses Value Yield
<S> <C>
Available for sale:
U.S. government securities:
U.S. Treasury notes $ 5,010 $ 35 $ - $ 5,045 6.74%
FHLB Debentures 8,998 30 - 9,028 6.92%
FNMA bond 1,003 14 - 1,017 6.55%
SLMA bond 1,014 57 - 1,071 7.07%
Other securities:
Smith Breeden short-term
government securities fund 15,000 - (277) 14,723 5.79%
Common stock 85 21 - 106 3.62%
-------- -------- -------- --------
Total $ 31,110 $ 157 $ (277) $ 30,990 6.34%
======== ========= ======== ========
Held to maturity:
U. S. Government securities:
U. S. Treasury notes $ 355 $ 4 $ - $ 359 6.44%
Other securities:
Tennessee Valley bond 145 - (1) 144 4.61%
FICO zero coupon bond 290 4 - 294 7.16%
-------- --------- -------- --------
Total $ 790 $ 8 $ (1) $ 797 6.38%
======== ========= ======== ========
</TABLE>
32
<PAGE>
In December 1995, the Company transferred $15.0 million of
held-to-maturity securities to the available-for-sale portfolio. No
such transfers were made in 1996.
The amortized cost and approximate market value of investment
securities by contractual maturity are shown below (dollars in
thousands). Actual maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations with
or without call premiums.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
--------------------------------- ----------------------------------
Amortized Fair Weighted Amortized Fair Weighted
Cost Value Average Cost Value Average
<S> <C>
Investment
securities
available for
sale:
Due within 1 year $ 18,004 $ 17,798 5.28% $ 20,095 $ 19,874 6.03%
Due after 1 year
through 5 years 20,208 20,086 6.72% 11,015 11,116 6.91%
Due after 5 years
through 10 12,110 12,071 7.12% - -
--------- -------- -------- --------
Total $ 50,322 $ 49,955 6.30% $ 31,110 $ 30,990 6.34%
========= ======== ======== ========
Investment securities
held to maturity:
Due within 1 year $ 260 $ 259 5.11% $ 388 $ 396 7.87%
Due after 1 year
through 5 years 144 144 5.29% 402 401 4.90%
--------- -------- -------- --------
Total $ 404 $ 403 5.17% $ 790 $ 797 6.38%
========= ======== ======== ========
</TABLE>
Sales of investment securities available for sale are summarized as
follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1996 1995 1994
<S> <C>
Proceeds from sales $ 3,194 $16,071 $ 5,176
Gross realized gains on sales 98 102 66
Gross realized losses on sales - 94 -
33
<PAGE>
4. LOANS RECEIVABLE
Loans receivable at December 31, 1996 and 1995 are summarized as follows (dollars in thousands):
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------------
1996 1995
<S> <C>
Real estate mortgage loans - secured by deeds of trust:
One- to four-family units $ 201,579 $ 199,917
Five or more dwelling units 22,455 21,503
Commercial real estate 7,524 4,191
Land and improvements 1,495 97
Real estate constructions loans - secured by deeds of trust -
one- to four-family units 2,731 5,379
Loans secured by savings accounts 670 523
Unsecured loans - line of credit 93 82
--------- ---------
Total 236,547 231,692
(Less) Add:
Loans in process (undisbursed loan funds) (1,822) (1,895)
Unamortized premiums, net 452 651
Deferred loan fees, net (528) (607)
Allowance for loan losses (1,311) (1,362)
--------- ---------
Total 233,338 228,479
Loans held for sale (130) (92)
--------- ---------
Loans receivable held for investment $ 233,208 $ 228,387
========= =========
Weighted average interest rate at end of period 7.80% 7.40%
</TABLE>
In 1995, the Company transferred, at market value, $7.4 million of
loans held for sale to loans held for investment, and recorded a lower
of cost or market adjustment of $35,000 through earnings. No such
transfers occurred in 1996.
At December 31, 1996 and 1995, the Company was servicing loans for
others with unpaid principal of $61,303,000 and $68,842,000,
respectively. Servicing loans for others generally consists of
collecting mortgage payments, maintaining escrow accounts, disbursing
payments to investors, and conducting foreclosure proceedings. Loan
servicing income is recorded on the accrual basis and includes
servicing fees from investors and certain charges collected from
borrowers, such as late payment fees. Income from loan servicing
amounted to $194,000 and $21,000 for the years ended December 31, 1996
and 1995, respectively. At December 31, 1996, the Company had $242,000
in escrow accounts for taxes and insurance.
34
<PAGE>
The activity in the allowance for loan losses is as follows (dollars in
thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1996 1995 1994
<S> <C>
Balance, beginning of year $ 1,362 $ 808 $ 387
Provision for loan losses 28 663 421
Charge-offs on mortgage loans (79) (109) 0
-------- ------- -----
Balance, end of year $ 1,311 $ 1,362 $ 808
======== ======= =====
</TABLE>
A loan is designated "impaired" when the Company determines it may be
unable to collect all amounts due according to the contractual terms of
the loan agreement, whether or not the loan is 90 days past due (see
Note 1). In addition, all loans designated as partially or completely
classified as Doubtful or Loss, and loans which meet the definition of
a troubled debt restructuring, are considered impaired.
The following table identifies the Company's total recorded investment
in impaired loans by type at December 31, 1996 and 1995 (dollars in
thousands).
<TABLE>
<CAPTION>
December 31,
------------------------
1996 1995
<S> <C>
Residential one- to four-family
non-homogenous loans $ 354 $ 1,544
Multi-family loans 821 830
Commercial real estate loans - -
Construction loans - 825
Non-mortgage loans 1 1
--------- ---------
Total impaired loans $ 1,176 $ 3,200
========= =========
</TABLE>
The related valuation allowances on impaired loans at December 31, 1996
and 1995 were $82,900 and $108,900, respectively, which were included
as part of the allowance for loan losses in the Consolidated Statements
of Financial Condition. The provision for losses and any related
recoveries are recorded as part of the provision for estimated losses
on loans in the Consolidated Statements of Operations. For the years
ended December 31, 1996 and 1995, the Company recognized interest on
impaired loans of $145,000 and $61,000, respectively. Interest not
recognized on impaired loans at December 31, 1995 amounted to $60,000.
No impaired loans were on nonaccrual status at December 31, 1996, and
therefore no interest was uncollected on impaired loans. During the
year ended December 31, 1996, the Company's average investment in
impaired loans was $862,000, compared to $483,000 in 1995.
35
<PAGE>
Nonperforming loans consist of restructured loans not performing in
accordance with their restructured terms, and all nonaccrual loans.
Nonaccrual loans are loans on which the Company has ceased the accrual
of interest for any one of the following reasons: (a) the payment of
interest is 90 days or more delinquent, (b) the loan is in the process
of foreclosure, or (c) the collection of interest and/or principal is
not probable under the contractual terms of the loan agreement.
Nonperforming assets include all nonperforming loans and REO.
Nonperforming assets as of December 31, 1996 and 1995 were as follows
(dollars in thousands).
<TABLE>
<CAPTION>
December 31,
--------------------
1996 1995
<S> <C>
Real estate mortgage loans - secured by deeds of trust:
One- to four-family units - in foreclosure $ 886 $1,218
One- to four family units - not in foreclosure 477 326
Five or more dwelling units - 830
Construction loans - 825
Equity lines of credit 30 -
Nonmortgage - 1
Real estate owned - -
------ ------
Total nonperforming assets $1,393 $3,200
====== ======
</TABLE>
At December 31, 1996 and 1995, the Company had $1,393,000 and
$1,545,000, respectively, of nonaccrual loans past due 90 days or more.
In addition, at December 31, 1996 and 1995, the Company had $2.9
million and $1.7 million, respectively, of loans which were less than
90 days delinquent but were identified as having risk characteristics
which indicated that collection of principal and interest may not be
certain. For the years ended 1996 and 1995, the effect on interest
income had nonaccrual and other impaired loans been performing in
accordance with contractual terms was approximately $89,000 and
$60,000, respectively.
Loans that have had a modification of terms are individually reviewed
to determine if they meet the definition of a troubled debt
restructuring. At December 31, 1996, the Company had three loans
totaling $354,000 which met the definition of a troubled debt
restructuring, all of which were current and paying according to the
terms of their contractually restructured agreements on December 31,
1996. The Company had no restructured loans at December 31, 1995.
At December 31, 1996 and 1995, all nonperforming loans were secured by
properties located within the state of California.
The following table presents an analysis of general and specific
allowances at the dates presented (dollars in thousands):
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
------------------------------------- -----------------------------------
Specific General Specific General
Allowance Allowance Total Allowance Allowance Total
<S> <C>
One- to four-family $ - $ 911 $ 911 $ 32 $1,049 $1,081
Multi-family - 171 171 - 143 143
Commercial real estate - 174 174 - 58 58
Construction and land - 20 20 - 77 77
Other 1 34 35 3 - 3
----- ------ ------ ----- ------ ------
Total valuation
allowances $ 1 $1,310 $1,311 $ 35 $1,327 $1,362
===== ====== ====== ===== ====== ======
</TABLE>
36
<PAGE>
During 1995, the Company originated a one- to four-family residential
loan of $181,000 to facilitate the sale of REO. No interest rate or
term concessions were made on the loan. The Company made no other loans
to facilitate sales during 1996 or 1995.
The Company made conforming loans to executive officers, directors,
subsidiary, and their affiliates in the ordinary course of business. An
analysis of the activity of these loans is as follows (dollars in
thousands):
<TABLE>
<CAPTION>
Year Ended
December 31,
---------------------
1996 1995
<S> <C>
Balance, beginning of period $822 $852
New loans and line of credit advances 0 0
Repayments (11) (30)
---- ----
Balance, end of period $811 $822
==== ====
</TABLE>
Under Office of Thrift Supervision ("OTS") regulations, the Company may
not make real estate loans to one borrower in an amount exceeding 15%
of the Bank's unimpaired capital and surplus, plus an additional 10%
for loans secured by readily marketable collateral. At December 31,
1996 and 1995, such limitation would have been approximately $5,414,600
and $5,845,600, respectively. There were no loans outstanding in excess
of this limitation.
The majority of the Company's loans are secured by real estate
primarily located in Santa Cruz, Monterey, Santa Clara, and San Benito
counties. The Company's credit risk is therefore primarily related to
the economic conditions of this region. Loans are generally made on the
basis of a secure repayment source which is based on a detailed cash
flow analysis; however, collateral is generally a secondary source for
loan qualification. It is the Company's policy to originate loans with
a loan to value ratio on secured loans greater than 80% with private
mortgage insurance. Management believes this practice mitigates the
Company's risk of loss.
5. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable as of December 31, 1996 and 1995 was as
follows (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
------------------
1996 1995
<S> <C>
Interest receivable on loans $1,341 $1,376
Interest receivable on mortgage backed securities 792 387
Interest receivable on other investments 423 346
------ ------
Total $2,556 $2,109
====== ======
</TABLE>
37
<PAGE>
6. INVESTMENT IN FHLB STOCK
As a member of the Federal Home Loan Bank of San Francisco ("FHLB"),
the Bank is required to own capital stock in an amount specified by
regulation. As of December 31, 1996 and 1995, the Bank owned 50,404 and
25,421 shares, respectively, of $100 par value FHLB stock. The amount
of stock owned meets the last annual regulatory determination. Each
Federal Home Loan Bank is authorized to make advances to its members,
subject to such regulation and limitations as the OTS may prescribe
(see Note 9).
7. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at December 31, 1996
and 1995 (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------
1996 1995
<S> <C>
Land $ 2,104 $ 1,388
Buildings and improvements 2,847 2,403
Equipment 1,569 1,700
------- -------
Total, at cost 6,520 5,491
Less accumulated depreciation (1,633) (1,461)
------- -------
Total $ 4,887 $ 4,030
======== ========
</TABLE>
Depreciation expense was $372,000, $362,000, and $318,000 for the years
ended December 31, 1996, 1995, and 1994, respectively.
8. SAVINGS DEPOSITS
A summary of savings deposits and related weighted average interest
rates for the years ended December 31, 1996 and 1995 follows (dollars
in thousands):
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
------------------------------ --------------------------------
Weighted Weighted
Average % of Average % of
Amount Rate Total Amount Rate Total
--------- ---------- -------- --------- ---------- --------
<S> <C>
Consumer accounts:
Passbook accounts $ 13,423 1.90% 4.22% $ 14,566 2.04% 6.77%
Checking accounts 13,944 .58% 4.38% 12,251 .73% 5.69%
Money market accounts 37,534 3.58% 11.80% 15,697 2.70% 7.29%
Certificate accounts:
Jumbo accounts 49,217 5.51% 15.47% 42,011 5.89% 19.51%
Other term accounts 204,027 5.60% 64.13% 130,759 5.62% 60.74%
-------- ------- -------- -------
Total $318,145 100.00% $215,284 100.00%
======== ======= ======== =======
Weighted average interest
rate 4.88% 4.99%
</TABLE>
38
<PAGE>
A summary of certificate accounts by maturity as of December 31, 1996
and 1995 follows (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
------------------------
1996 1995
<S> <C>
Within six months $104,001 $ 72,410
Six months to one year 83,849 66,616
One to two years 56,885 25,570
Two to three years 6,559 4,534
Over three years 1,950 3,640
-------- --------
Total $253,244 $172,770
======== ========
</TABLE>
Savings deposits included $57,676,000 and $43,018,000 of jumbo accounts
($100,000 or greater) at December 31, 1996 and 1995, respectively. A
portion of accounts greater than $100,000 are included in
noncertificate accounts, such as passbook, checking and money market
accounts. The Company does not offer premium rates on jumbo certificate
accounts. The Savings Association Insurance Fund only insures account
balances up to $100,000.
Interest expense on savings deposits is summarized as follows (dollars
in thousands):
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1995 1994
---- ---- ----
<S> <C>
Passbook savings $ 254 $ 308 $ 409
Checking accounts 78 120 110
Money market accounts 695 395 237
Certificates of deposit 9,922 9,779 7,198
------- ------- ------
Total $10,949 $10,602 $7,954
======= ======= ======
</TABLE>
At December 31, 1996 and 1995, accrued interest payable on savings
deposits, included in other liabilities, was $3,000 and $10,000,
respectively.
In December 1996, the Company assumed approximately $102,063,000 of
deposits from Fremont Investment and Loan in exchange for cash and
certain other assets. A core deposit intangible asset of approximately
$3,668,000 was recorded at the date of assumption. The Company acquired
no premises or equipment in the transaction.
39
<PAGE>
9. FHLB ADVANCES
Federal Home Loan Bank advances outstanding are summarized below
(dollars in thousands):
<TABLE>
<CAPTION>
December 31,
----------------------
1996 1995
<S> <C>
Maturity:
1996 $ - $43,738
1997 38,225 -
1998 1,000 -
2004 282 282
2005 1,500 1,500
2006 4,800 -
2010 1,000 1,000
------- -------
Total $46,807 $46,520
======= =======
Weighted Average Rate
during the year 5.75% 6.00%
Weighted Average Rate
at the end of the year 5.72% 5.84%
</TABLE>
At December 31, 1996 and 1995, advances were secured by pledged
investment securities and mortgage backed securities with carrying
values totaling $77,629,000 and $33,368,000 respectively and the Bank's
investment in FHLB stock (see Note 6). At December 31, 1996 and 1995,
FHLB advances were also secured by mortgage loans with carrying values
of $178,381,000 and $153,003,000, respectively.
For the years ended December 31, 1996 and 1995, the maximum amount
borrowed during the year was $99,607,000 and $68,032,000, respectively.
For the years ended December 31, 1996 and 1995, the average amount of
FHLB advances outstanding was $43,619,000 and $45,744,000,
respectively.
40
<PAGE>
10. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
At December 31, 1996 and 1995, the Company held $13,000,000 and
$17,361,000, respectively, of agreements to repurchase securities,
collateralized by United States Treasury Notes, Student Loan Marketing
Association Notes, Federal Home Loan Bank Bonds, and Federal National
Mortgage Association securities which were controlled by the Company.
The following table summarizes additional data concerning reverse
repurchase agreements at or during the years ended December 31, 1996
and 1995 (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
----------------------
1996 1995
<S> <C>
Maturity:
1996 $ - $ 4,361
1997 13,000 13,000
------- -------
Outstanding balance at year end $13,000 $17,361
Average balances during the year $14,644 $14,497
Maximum month-end outstanding balances 16,648 26,124
Weighted average rate during the year 5.98% 6.06%
Weighted average rate at the end of the
year 5.94% 5.91%
Securities held as collateral for reverse
repurchase agreements, at year end:
Par value $14,402 $17,466
Amortized cost 14,784 18,020
Market value 14,910 18,226
</TABLE>
11. INCOME TAXES
The components of the provision for income taxes for the years ended
December 31, 1996, 1995 and 1994 are as follows (dollars in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------
1996 1995 1994
<S> <C>
Current:
Federal $ 626 $ 343 $ 842
State 163 127 330
------ ----- ------
Total 789 470 1,172
Deferred:
Federal (173) (44) (144)
State 7 (12) (79)
------ ----- ------
Total $ 623 $ 414 $ 949
====== ===== ======
</TABLE>
41
<PAGE>
The differences between the statutory federal income tax rate and the
Company's effective tax rate, expressed as a percentage of income
before income taxes, are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------
1996 1995 1994
---- ---- ----
<S> <C>
Statutory federal tax rate 34.0% 34.0% 34.0%
California franchise tax, net
of federal
income tax benefit 7.6% 7.0% 7.6%
Other 0.7% (2.9%) 1.6%
----- ----- -----
Total 42.3% 38.1% 43.2%
===== ===== =====
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities as of December 31,
1996 and 1995 are presented below (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
-----------------------
1996 1995
<S> <C>
Deferred tax assets:
Deferred loan fees $ 89 $ 332
Compensation deferred for tax purposes 383 378
Allowance for loan losses 210 154
State income taxes (32) (37)
Core deposits 362 262
Unrealized loss on securities available for sale 354 12
Other 41 -
------- -------
Total gross deferred tax assets 1,407 1,101
Deferred tax liabilities:
Tax over book depreciation (123) (143)
FHLB stock dividends (445) (488)
Mark-to-market adjustment - (128)
Other (50) (60)
------ ------
Total gross deferred tax liabilities (618) (819)
------ ------
Net deferred tax asset $ 789 $ 282
====== ======
</TABLE>
Legislation regarding bad debt recapture was signed into law by the
President during the quarter ended September 30, 1996. The new law
requires recapture of reserves accumulated after 1987. The recapture
tax on post-1987 reserves must be paid over a six year period starting
in 1996. The payment of the tax can be deferred in each of 1996 and
1997 if an institution originates at least the same average annual
principal amount of mortgage loans that it originated in the six years
prior to 1996. Management believes that the newly enacted bad debt
recapture legislation will not have a material impact on the operations
of the Company.
In accordance with SFAS 109, a deferred tax liability has not been
recognized for the tax bad debt reserves of the Company that arose in
tax years that began prior to December 31, 1987. At December 31, 1996,
the portion of the tax bad debt reserves attributable to pre-1988 tax
years was
42
<PAGE>
approximately $5,700,000. The amount of unrecognized deferred tax
liability could be recognized if, in the future, there is a change in
federal tax law, the savings institution fails to meet the definition
of a "qualified savings institution," or the bad debt reserve is used
for any purpose other than absorbing bad debt losses.
12. REGULATORY CAPITAL REQUIREMENTS AND OTHER REGULATORY
MATTERS
Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of its assets,
liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. Capital amounts and classification are
also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors. Failure to meet minimum
capital requirements can initiate certain mandatory and possible
additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Company's financial
statements. Management believes, as of December 31, 1996, that the Bank
meets all capital adequacy requirements to which it is subject.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
(FIRREA) requires the Bank to meet certain minimum capital standards.
Under these standards the Bank must maintain core capital in an amount
not less than 3% of tangible assets plus qualifying intangibles,
tangible capital in an amount not less than 1.5% of tangible assets,
and risk-based capital in an amount not less than 8.0% of risk-weighted
assets. At December 31, 1996, the Bank's regulatory capital exceeded
the minimum requirement of each regulatory capital standard in effect
on that date as follows (dollars in thousands):
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
------------------------------------- -----------------------------------
Minimum Minimum
Actual Requirement Actual Requirement
----------------- ----------------- ---------------- -----------------
Capital Ratio Capital Ratio Capital Ratio Capital Ratio
<S> <C>
Capital
Standards:
Tangible $34,440 8.28% $ 6,239 1.50% $37,153 11.65% $ 4,783 1.50%
Core (leverage) 34,787 8.36% 12,488 3.00% 37,804 11.83% 9,585 3.00%
Risk-based 36,097 19.22% 15,026 8.00% 39,131 24.42% 12,817 8.00%
</TABLE>
43
<PAGE>
The following table is a reconciliation of the Bank's capital under
generally accepted accounting principles with its regulatory capital at
December 31, 1996 and 1995 (dollars in thousands):
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
---------------------------------- ---------------------------------
Core, Total Core, Total
Tier 1 Risk- Tier 1 Risk-
Tangible Risk-Based Based Tangible Risk-Based Based
Capital Capital Capital Capital Capital Capital
--------- ---------- ------- -------- ---------- -------
<S> <C>
Balances at end of year:
Capital per Bank's
financial statements $37,939 $37,939 $37,939 $37,920 $37,920 $37,920
Adjustments for regulatory
capital purposes:
Core deposit premium (3,978) (3,631) (3,631) (651) - -
Unrealized (gain) loss on
securities available for
sale, net of taxes 489 489 489 (116) (116) (116)
Excess mortgage
servicing rights (10) (10) (10) - - -
General valuation
allowances - - 1,310 - - 1,327
------- ------- ------- ------- ------- -------
Regulatory capital $34,440 $34,787 $36,097 $37,153 $37,804 $39,131
======= ======= ======= ======= ======= =======
</TABLE>
The OTS's prompt corrective action standards have established five
capital tiers: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. The regulations provide that a savings institution is
well capitalized if its risk-based capital to risk weighted assets
ratio is 10% or greater, its core capital to risk-weighted assets ratio
is 6% or greater, its leverage ratio, or ratio of core capital to
adjusted total assets, is 5% or greater, and the institution is not
subject to a capital directive. As of December 31, 1996, the most
recent notification from the OTS categorized the Bank as well
capitalized under the regulatory framework for prompt corrective
action. There are no conditions or events since that notification that
management believes have changed the institution's category. The Bank
exceeded the minimum requirement guidelines to be categorized as a well
capitalized institution at December 31, 1996 and 1995 as follows
(dollars in thousands):
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
------------------------------------- -----------------------------------
Minimum Minimum
Actual Requirement Actual Requirement
----------------- ----------------- ---------------- -----------------
Capital Ratio Capital Ratio Capital Ratio Capital Ratio
<S> <C>
Capital Standards
(Well Capitalized):
Leverage $34,787 8.36% $20,814 5.00% $37,804 11.83% $15,974 5.00%
Tier 1 risk based 34,787 18.52% 11,270 6.00% 37,804 23.60% 9,613 6.00%
Total risk based 36,097 19.22% 18,783 10.00% 39,131 24.42% 16,021 10.00%
</TABLE>
At periodic intervals, both the OTS and the Federal Deposit Insurance
Corporation ("FDIC") routinely examine the Company's financial
statements as part of their legally prescribed oversight of the savings
and loan industry. Based on these examinations, the regulators can
direct that a savings and loan association's financial statements be
adjusted in accordance with their findings.
A future examination by the OTS or FDIC could include a review of
certain transactions or other amounts reported in the Company's
financial statements. The extent, if any, to which a forthcoming
regulatory examination may ultimately result in adjustments to the
financial statements cannot presently be determined.
44
<PAGE>
Currently, the OTS has deferred implementation of the interest rate
risk component of its regulatory capital rule, under which savings
associations with "above normal" (i.e. greater than 2%) interest rate
risk exposure would be subject to a deduction from total risk-based
capital. If the Bank had been subject to adding an interest rate risk
component to its risk-based capital standard at December 31, 1996, the
Bank's total risk-weighted capital would have been reduced from 19.22%
to 16.24%. At December 31, 1996, the Bank met each of its capital
requirements, in each case on a fully phased-in basis.
Federal legislation to recapitalize and fully fund the Savings
Association Insurance Fund (SAIF) was signed into law on September 30,
1996. The legislation imposed a special one-time assessment on
SAIF-member institutions, including the Bank, of 65.7 basis points on
SAIF assessable deposits held as of March 31, 1995. The Company
recorded a pre-tax expense of $1.4 million in 1996 ($815,000 after-tax
or $.26 per share) as a result of the FDIC special assessment.
The legislation also spreads the obligations for payment of the
Financing Corporation ("FICO") bonds across all SAIF and BIF members.
Beginning on January 1, 1997, BIF deposits will be assessed for FICO
payments at a rate of 20% of the rate assessed on SAIF deposits. Based
on current estimates by the FDIC, BIF deposits will be assessed a FICO
payment of 1.3 basis points, while SAIF deposits will pay an estimated
6.5 basis points on the FICO bonds. Full pro rata sharing of the FICO
payments between BIF and SAIF members will occur on the earlier of
January 1, 2000 or the date the BIF and SAIF are merged. The Funds Act
specifies that the BIF and SAIF will be merged on January 1, 1999
provided no savings associations remain as of that time.
As a result of the Funds Act, the FDIC recently proposed to lower SAIF
assessments to 0 to 27 basis points effective January 1, 1997, a range
comparable to that of BIF members. However, SAIF members will continue
to make the higher FICO payments described above. Management cannot
predict the level of FDIC insurance assessments on an on-going basis,
whether the savings charter will be eliminated, or whether the BIF and
SAIF will eventually be merged.
The Company's assessment rate for fiscal 1996 was 26 basis points.
Excluding the special premium insurance assessment, the Company paid
SAIF deposit insurance premiums of $532,000 in 1996, compared to
$516,000 in 1995.
45
<PAGE>
13. INTEREST RATE RISK
The Company is engaged principally in providing first mortgage,
commercial real estate, land, and construction loans to individuals. At
December 31, 1996 and 1995, approximately $232,123,000 and $227,223,000
of the Company's assets were comprised of loans secured by real estate.
At December 31, 1996 and 1995, the mortgage loan portfolio consisted of
63% adjustable rate and 37% fixed rate mortgages.
At December 31, 1996 and 1995, the composition of adjustable and fixed
rate loans was as follows (dollars in thousands):
<TABLE>
<CAPTION>
December 31,
----------------------
1996 1995
<S> <C>
Adjustable Rate:
Term to Adjustment:
1 month to 1 year $128,510 $133,871
1 year to 5 years 19,754 10,125
-------- --------
Total $148,264 $143,996
======== ========
Fixed Rate:
Term to Maturity:
1 month to 3 years $ 1,730 $ 1,030
3 years to 5 years 543 599
5 years to 10 years 3,302 2,681
10 years to 20 years 7,154 7,892
Over 20 years 73,656 73,643
-------- --------
Total $ 86,385 $ 85,845
======== ========
</TABLE>
The adjustable rate loans have interest rate adjustment limitations and
are indexed to the Federal Home Loan Bank Eleventh District cost of
funds, the six-month London Interbank Overnight Rate, and the one-year
U.S. government treasury rate. Future market factors may affect the
correlation of the interest rate adjustment with the rates the Company
pays on the short-term deposits that have been primarily utilized to
fund these loans.
At December 31, 1996, the Company had interest earning assets of
$407,780,000, having a weighted average effective yield of 7.54% (the
total of weighted average maturities for fixed rate assets and weighted
average period to adjustments for adjustable rate assets), and interest
bearing liabilities of approximately $377,952,000, having a weighted
average effective interest rate of 5.10%.
At December 31, 1995, the Company had interest earning assets of
$319,345,000, having a weighted average effective yield of 7.32%, and
interest bearing liabilities of approximately $279,165,000, having a
weighted average effective interest rate of 5.25%.
46
<PAGE>
14. WHOLLY OWNED SUBSIDIARY
Monterey Bay Bank's wholly owned subsidiary, Portola, is engaged on an
agency basis in the sale of insurance, mutual funds, and annuity
products primarily to the Company's customers and members of the local
community, and acts as trustee on the Company's deeds of trust.
Condensed statements of financial condition of Portola as of December
31, 1996 and 1995, and condensed statements of operations and cash
flows for the years ended December 31, 1996, 1995 and 1994 are as
follows (dollars in thousands):
CONDENSED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
December 31,
---------------------
1996 1995
<S> <C>
ASSETS:
Cash and due from depository institutions $ 77 $ 81
Commissions receivable 0 148
Investment securities available for sale 199 0
Investment securities held to maturity 153 356
Premises and equipment, net 6 4
Accrued interest receivable and other assets 6 (14)
---- -----
TOTAL $441 $ 575
==== =====
LIABILITIES AND STOCKHOLDER'S EQUITY:
Total liabilities $ 2 $ 74
---- -----
Stockholder's equity:
Retained earnings 434 496
Capital stock 5 5
---- -----
Total stockholder's equity 439 501
---- -----
TOTAL $441 $ 575
==== =====
</TABLE>
CONDENSED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1996 1995 1994
---- ---- ----
<S> <C>
Interest income on investments $ 24 $ 17 $ -
Commissions and fee income 138 464 556
Expenses (268) (344) (357)
------ ------ ------
Income (loss) before income taxes (106) 137 199
Income tax expense (benefit) (44) 56 82
------ ------ ------
Net income (loss) $ (62) $ 81 $ 117
====== ====== ======
</TABLE>
47
<PAGE>
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1996 1995 1994
---- ---- ----
<S> <C>
OPERATING ACTIVITIES:
Net income (loss) $ (62) $ 81 $ 117
Adjustments to reconcile net income (loss) to
net cash provided (used) by operating activities:
Depreciation and amortization 2 2 3
Amortization of discounts, net of premium 4 (7)
Change in:
Commissions receivable 148 (44) 47
Other assets (20) 27 (12)
Other liabilities (72) (195) 77
------ ------ ------
Net cash provided (used) by operating
activities - (136) 232
------ ------ ------
INVESTING ACTIVITIES:
Purchase of premises and equipment (4) (2) (2)
Proceeds from sale of premises - - 95
Purchase of investment securities (200) (254) (390)
Paydown on investment securities - 300 13
Proceeds from maturities of investment securities 200 160 -
------ ------ ------
Net cash provided (used) by investing activities (4) 204 (284)
------ ------ ------
NET INCREASE (DECREASE) IN CASH (4) 68 (52)
CASH AT BEGINNING OF YEAR 81 13 65
------ ------ ------
CASH AT END OF YEAR $ 77 $ 81 $ 13
====== ====== ======
</TABLE>
15. COMMITMENTS AND CONTINGENCIES
At December 31, 1996 and 1995, the Company was obligated under
non-cancelable operating leases for office space. Certain leases
contain escalation clauses providing for increased rentals based
primarily on increases in real estate taxes or on the average consumer
price index. Rent expense under operating leases, included in occupancy
and equipment expense, was approximately $158,000, $154,000 and
$175,000 for the years ended December 31, 1996, 1995 and 1994,
respectively.
Certain branches are leased by the Company under the terms of operating
leases expiring at various dates through the year 2003. At December 31,
1996, the minimum rental commitments, including renewal options, under
all non-cancelable operating leases with initial or remaining terms of
more than one year were as follows (dollars in thousands):
1997 $135
1998 75
1999 33
2000 35
Thereafter 112
----
Total $390
====
48
<PAGE>
The Company is a party to financial instruments with off balance sheet
risk in the normal course of business to meet the financing needs of
its customers. These financial instruments represent commitments to
fund loans and involve, to varying degrees, elements of interest rate
risk and credit risk in excess of the amount recognized in the
Consolidated Statements of Financial Condition. Credit risk is
mitigated by the Company's evaluation of the creditworthiness of
potential borrowers on a case-by-case basis.
Commitments to fund loans are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have expiration dates or other termination
clauses. Also, external market forces may impact the probability of
commitments being exercised; therefore, total commitments outstanding
do not necessarily represent future cash requirements. At December 31,
1996, the Company had outstanding commitments to originate loans of
$2,694,000.
16. STOCK BENEFIT PLANS
On August 24, 1995, the stockholders of the Company approved the 1995
Incentive Stock Option Plan (the "Stock Option Plan"). Under the Stock
Option Plan, 271,507 stock options were granted to the executive
officers and officers of the Company and its affiliate, the Bank. Each
option entitles the holder to purchase one share of the common stock at
the market value of the common stock on the date of grant. Options are
exercisable in whole or in part over five years, commencing one year
after the date of grant. However, all options become 100% exercisable
in the event that the employee terminates his employment due to death,
disability, or, to the extent not prohibited by the OTS, in the event
of a change in control of the Company or the Bank. An additional 4,733
options have been reserved for future grant. At December 31, 1996,
52,289 of the options granted were exercisable. No options had been
exercised to that date.
The Company also maintains the 1995 Stock Option Plan for Outside
Directors (the "Directors' Option Plan"), approved by the stockholders
of the Company on August 24, 1995. Each member of the Board of
Directors who is not an officer or employee of the Company or the Bank
was granted a non-statutory option to purchase shares of the common
stock. In the aggregate, members of the Board of Directors of the
Company were granted options to purchase 78,343 shares of common stock
at an exercise price equal to the market value of the common stock on
the date of grant. Options are exercisable in whole or in part over
five years, commencing one year after the date of grant. However, all
options become 100% exercisable in the event that the Director
terminates membership on the Board of Directors due to death,
disability, or, to the extent not prohibited by the OTS, in the event
of a change in control of the Company or the Bank. At December 31,
1996, 15,669 of the options granted were exercisable. No options had
been exercised to that date.
49
<PAGE>
Activity in the Company's stock option plans follows:
<TABLE>
<CAPTION>
Number Weighted
of Option Average
Shares Price Exercise Price
------- ---------------- --------------
<S> <C>
Outstanding at January 1, 1995 -
Granted August 24, 1995 357,577 $11.375 $11.375
Exercised - - -
Expired or canceled - - -
-------
Outstanding at December 31, 1995 357,577 11.375 11.625
Granted 15,227 13.375 to 14.750 13.767
Exercised - - -
Expired or canceled (17,787) 11.375 12.270
-------
Outstanding at December 31, 1996 355,017 11.375 to 14.750 14.750
Exercisable at December 31, 1996 67,958 11.375 14.750
</TABLE>
The Bank has established an Employee Stock Owner Plan and Trust
("ESOP") for eligible employees. Full-time employees employed with the
Company or Bank as of January 1, 1995, and full-time employees of the
Company or the Bank employed after such date who have been credited
with at least 1,000 hours during a twelve-month period, have attained
age 21, and were employed on the last business day of the year are
eligible to participate.
On February 14, 1995, the Conversion date, the ESOP borrowed $2.3
million from the Company and used the funds to purchase 287,500 shares
of common stock issued in the Conversion. The loan is being repaid
principally by contributions by the Bank to the ESOP, but may be paid
from the Company's discretionary contributions to the ESOP over a ten
year period. At December 31, 1996, the loan had an outstanding balance
of $1.8 million and an interest rate of 8.0%. Interest expense for the
obligation was $166,000 and $184,000, respectively, for the years ended
December 31, 1996 and 1995. Shares purchased with the loan proceeds are
held in trust for allocation among participants as the loan is paid.
Contributions to the ESOP and shares released from the loan collateral
in an amount proportional to the repayment of the ESOP loan is
allocated among participants on the basis of compensation, as described
in the plan, in the year of allocation. Benefits generally become 100%
vested after seven years of credited service. However, in the event of
retirement, disability or death, as defined in the plan, any unvested
portion of benefits shall vest immediately. Forfeitures will be
reallocated among participating employees, in the same proportion as
contributions. Benefits are payable upon separation from service based
on vesting status and share allocations made. As of December 31, 1996,
57,500 shares were allocated to participants and committed to be
released. As shares are released from collateral, the shares become
outstanding for earnings per share computations. As of December 31,
1996, the fair market value of the 230,000 unearned shares was
$3,392,500.
The Company maintains a Performance Equity Program for Officers and a
Recognition and Retention Plan for Outside Directors (the "RRP"). The
purpose of the RRP is to provide executive officers, officers, and
directors of the Company with a proprietary interest in the Company in
a manner designed to encourage such persons to remain with the Company.
A trust established for the RRP acquired an aggregate of 143,750 shares
of the Company's common stock during 1995 and 1996; 19,980 grant shares
vested and were issued during 1996; 106,417 shares are the subject of
outstanding awards to officers and directors and 17,353 remain reserved
for future awards. Awards vest at a rate of 20% per year for directors
and officers, commencing one year from the date of award. Awards become
100% vested upon termination of employment due to death,
50
<PAGE>
disability, or following a change in control of the Company. Some
awards are based on the attainment of certain performance goals and are
forfeited it such goals are not met. In 1996, 6,438 shares were
forfeited due to unmet goals and 5,032 shares were forfeited due to
cessation of employment.
The Company recorded compensation expense for the ESOP and RRP of
$599,000 and $326,000 respectively, for the years ended December 31,
1996 and 1995.
In October 1995, the FASB issued Statement of Financial Standards No.
123 ("SFAS 123"), Accounting for Stock Based Compensation, which
established accounting and disclosure requirements using a fair value
based method of accounting for stock based employee compensation plans.
Under SFAS 123, beginning in 1996 the Company had the option to either
adopt the new fair value based accounting method or continue the
intrinsic value based method and provide pro forma net income and
earnings per share as if the accounting provisions of SFAS 123 had been
adopted. The Company has adopted only the disclosure requirements of
SFAS 123, and applies Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock issued to Employees," in accounting for its stock
options. Had compensation cost been determined in accordance with SFAS
No. 123, the Company's net income and earnings per share would have
been changed to the pro forma amounts indicated below (dollars in
thousands).
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------
1996 1995
<S> <C>
Net income:
As reported $ 852 $ 673
Pro forma 588 416
Net income per share:
As reported $ .27 $ .17
Pro forma .19 .09
</TABLE>
The fair value of each option was estimated at the date of grant using
an estimated future value of the Company's stock discounted at the
current risk free rate of interest.
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------
1996 1995
<S> <C>
Dividend yield 0.72% 0.00%
Growth rate 25.19% 22.12%
Risk free interest rate 6.21% 5.71%
Expected term (years) 5.5 6.0
</TABLE>
The following table summarizes stock option information at year-end
1996:
<TABLE>
<CAPTION>
Exercise Number of Remaining Exercisable
Price Options Life Options
------------------- --------------- ---------------- ---------------
<S> <C>
$11.375 339,790 9.72 years 67,958
13.375 7,727 10.00 years -
14.750 7,500 10.00 years -
$11.375 - 14.750 355,017 9.71 years 67,958
</TABLE>
51
<PAGE>
17. 401(k) PROFIT SHARING PLAN
The Company maintains a profit sharing plan for employees who are 21
years of age and who have been employed for 90 days and have completed
1,000 hours of service. Effective December 1, 1993, the Company amended
the Plan to offer a 401(k) feature. Expense for the 401(k) profit
sharing plan amounted to $144,000 for the year ended December 31, 1994.
In 1994, the Company contributed 15% of the eligible salaries of
eligible participants to the 401(k) plan. The Company did not
contribute any portion of employees' salaries to the 401(k) plan in
1995 and 1996.
The trust that administers the 401(k) profit sharing plan had assets of
$1,288,000 and $1,081,000 at other financial institutions as of
December 31, 1996 and 1995, respectively.
18. SALARY CONTINUATION AND RETIREMENT PLAN
The Company maintains a Salary Continuation Plan for the benefit of
certain officers and a Retirement Plan for members of the Board of
Directors of the Company. Officers participating in the Salary
Continuation Plan are entitled to receive a monthly payment for a
period of 10 years upon retirement. Directors of the Company who have
served on the Board of Directors for a minimum of nine years are
entitled under the Retirement Plan to receive a quarterly payment equal
to the amount of their quarterly retainer fee in effect at the date of
retirement for a period of ten years. The Salary Continuation Plan and
the Retirement Plan provide that payments will be accelerated upon the
death of a Participant or in the event of a change in control of the
Company. As of December 31, 1996 and 1995, there were eight officers
and Directors participating in the Plan.
The actuarial present value of the accumulated plan benefit obligation,
calculated using a discount rate of 7.5%, was $914,000 at December 31,
1996 and $820,000 at December 31, 1995. Plan assets are not separately
segregated for purposes of paying benefits under the Salary
Continuation and Retirement Plans. The Company accrued pension
liability expenses of $35,000 and $94,000 under the Plans for the years
ended December 31, 1996 and 1994, respectively. The Company did not
accrue pension expenses during 1995. Such expense amounts approximated
an actuarial computed net periodic plan costs for each period. Prepaid
pension costs are immaterial to the Consolidated Statement of Financial
Condition. As such, no prepaid plan costs are included in the
Consolidated Statement of Financial Condition.
19. PARENT COMPANY FINANCIAL INFORMATION
The Company and its subsidiary, the Bank, file consolidated federal
income tax returns in which the taxable income or loss of the Company
is combined with that of the Bank. The Company's share of income tax
expense is based on the amount which would be payable if separate
returns were filed. Accordingly, the Company's equity in the net income
of its subsidiaries (distributed and undistributed) is excluded from
the computation of the provision for income taxes for financial
statement purposes.
52
<PAGE>
The following presents Parent Company summary statements of financial
condition, operations, and cash flows for the years ended December 31,
1995 and 1996 (dollars in thousands). The Company had no operations
prior to 1995 and accordingly, summary operations data is not
presented.
SUMMARY STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------
1996 1995
---- ----
<S> <C>
ASSETS
Cash and due from depository institutions $ 588 $ 437
Mortgage backed securities available for sale 7,144 4,927
Investment securities available for sale 102 5,151
Other assets 55 -
Investment in subsidiary 37,939 37,920
-------- --------
TOTAL $ 45,828 $ 48,435
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Securities sold under agreements to repurchase $ - $ 713
Other liabilities 69 118
-------- --------
Total liabilities 69 831
Stockholders' equity (see Consolidated Statements
of Financial Condition) 45,759 47,604
-------- --------
TOTAL $ 45,828 $ 48,435
======== ========
</TABLE>
SUMMARY STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------
1996 1995
<S> <C>
Interest income:
Interest on mortgage backed securities
and investment securities $ 582 $ 690
Interest on ESOP 166 184
-------- --------
Total interest income 748 874
-------- --------
Interest expense:
Interest on reverse repurchase agreements 7 42
-------- --------
Total interest expense 7 42
-------- --------
Noninterest revenue 47 -
General and administrative expense 397 271
-------- --------
Income before income tax expense 391 561
Income tax expense 162 219
-------- --------
Income before undistributed net income of the Bank 229 342
Undistributed net income of the Bank 623 331
-------- --------
Net income $ 852 $ 673
======== ========
</TABLE>
53
<PAGE>
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------
1996 1995
---- ----
<S> <C>
OPERATING ACTIVITIES:
Net income $ 852 $ 673
Adjustments to reconcile net income to net cash provided by
operating activities:
Undisbursed net income of subsidiary (623) (331)
Amortization of premiums 8 41
Compensation expense related to ESOP shares released 307 277
Change in interest receivable 86 (134)
Change in other assets 53 (35)
Change in income taxes payable and deferred income taxes (150) 149
Change in other liabilities (49) 99
-------- --------
Net cash provided by operating activities 484 739
-------- --------
INVESTING ACTIVITIES:
Investment in subsidiary - (13,513)
Purchases of mortgage backed securities available for sale (5,284) (5,891)
Paydowns on mortgage backed securities 3,010 998
Purchase of investment securities available for sale (3,593) (6,634)
Proceeds from maturities of investment securities 8,500 1,500
Proceeds from sales of investment securities 85 -
-------- --------
Net cash provided by (used in) investing activities 2,718 (23,540)
--------- --------
FINANCING ACTIVITIES:
Proceeds from the sale of common stock - 24,726
(Repayments) proceeds from reverse repurchase agreements, net (713) 713
Cash dividends (165) -
Purchases of treasury stock (2,173) (2,201)
--------- --------
Net cash (used in) provided by financing activities (3,051) 23,238
--------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 151 437
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 437 -
--------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 588 $ 437
========= ========
</TABLE>
20. ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of the Company's
financial instruments is in accordance with the provisions of Statement
of Financial Accounting Standards No. 107, Disclosures about Fair Value
of Financial Instruments ("SFAS 107"). The estimated fair value amounts
have been computed by the Company using quoted market prices where
available or other appropriate valuation methodologies as discussed
below.
The following factors should be considered in assessing the accuracy
and usefulness of the estimated fair value data discussed below:
o Because no market exists for a significant portion of the
Company's financial instruments, fair value estimates are based on
judgments regarding future expected loss experience, current
economic conditions, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in
nature and involve uncertainties and matters of significant
54
<PAGE>
judgment and therefore cannot be determined with precision.
Changes in these assumptions could significantly affect the
estimates.
o These estimates do not reflect any premium or discount that could
result from offering for sale at one time the Company's entire
holding of a particular financial asset.
o SFAS 107 excludes from its disclosure requirements certain
financial instruments and various significant assets and
liabilities that are not considered to be financial instruments.
Because of these limitations, the aggregate fair value amounts
presented in the following tables do not represent the underlying value
of the Company at December 31, 1996 and 1995.
The following methods and assumptions were used by the Company in
computing the estimated fair values:
a. Cash and Cash Equivalents, Certificates of Deposit and Federal
Home Loan Bank Stock - Current carrying amounts approximate
their estimated fair value.
b. Mortgage backed Securities and Investment Securities - Fair
value of these securities are based on year-end quoted market
prices.
c. Loans Held for Sale - The fair value of these loans has been
based on market prices of similar loans traded in the
secondary market.
d. Loans Receivable Held for Investment - For fair value
estimation purposes, these loans have been categorized by type
of loan (e.g., one- to four-unit residential) and then further
segmented between adjustable or fixed rates. Where possible,
the fair value of these groups of loans has been based on
secondary market prices for loans with similar
characteristics. The fair value of the remaining loans has
been estimated by discounting the future cash flows using
current interest rates being offered for loans with similar
terms to borrowers of similar credit quality. Prepayment
estimates were based on historical experience and published
data for similar loans.
e. Demand Deposits - Current carrying amounts approximate
estimated fair value.
f. Certificate Accounts - Fair value has been estimated by
discounting the contractual cash flows using current market
rates offered in the Company's market area for deposits with
comparable terms and maturities.
g. FHLB Advances - Fair value was estimated by discounting the
contractual cash flows using current market rates offered for
advances with comparable terms and maturities.
h. Commitments to Extend Credit - The majority of the Company's
commitments to extend credit carry current market interest
rates if converted to loans. Because commitments to extend
credit are generally unassignable by either the Company or the
borrower, they only have value to the Company and the
borrower. The Company does not have deferred commitment fees
on loans prior to origination.
55
<PAGE>
The carrying amounts and estimated fair values of the Company's
financial instruments as of December 31, 1996 and 1995 were as follows
(dollars in thousands):
<TABLE>
<CAPTION>
December 31, 1996
------------------------
Carrying Fair
Amount Value
-------- -----
<S> <C>
Assets:
Cash and cash equivalents $ 4,978 $ 4,978
Certificates of deposit 199 199
Investment securities available for sale 49,955 49,955
Investment securities held to maturity 404 403
Mortgage backed securities available for sale 116,610 116,610
Mortgage backed securities held to maturity 173 169
Loans receivable held for investment 233,208 233,788
Loans held for sale 130 130
Federal Home Loan Bank stock 5,040 5,040
Liabilities:
Consumer accounts 64,901 64,901
Certificate accounts 253,244 254,508
FHLB advances 46,807 47,423
Securities sold under agreements to repurchase 13,000 13,024
Commitments to extend credit - -
</TABLE>
<TABLE>
<CAPTION>
December 31, 1995
-------------------------
Carrying Fair
Amount Value
<S> <C> -------- --------
Assets:
Cash and cash equivalents $ 4,217 $ 4,217
Certificates of deposit 782 782
Investment securities available for sale 30,990 30,990
Investment securities held to maturity 790 797
Mortgage backed securities available for sale 52,417 52,417
Mortgage backed securities held to maturity 205 199
Loans receivable held to maturity 228,387 228,084
Loans held for sale 92 92
Federal Home Loan Bank stock 2,542 2,542
Liabilities
Demand deposits 42,514 42,514
Certificate accounts 172,770 173,916
FHLB advances 46,520 46,585
Securities sold under agreements to repurchase 17,361 17,558
Commitments to extend credit - -
</TABLE>
56
<PAGE>
21. LIQUIDATION ACCOUNT
At the time of the Conversion, the Bank established a liquidation
account in an amount equal to its equity as of September 30, 1994. The
liquidation account is maintained by the Bank for the benefit of
depositors as of the eligibility record date who continue to maintain
their accounts at the Bank after the conversion. The liquidation
account is reduced annually to the extent that eligible account holders
have reduced their qualifying deposits as of each anniversary date.
Subsequent increases do not restore an eligible account holder's
interest in the liquidation account. In the event of a complete
liquidation of the Bank (and only in such an event), each eligible
account holder will be entitled to receive a distribution from the
liquidation account in an amount proportionate to the current adjusted
qualifying balances for accounts then held, before any liquidation
distribution may be made with respect to the stockholders. Except for
the repurchase of stock and payment of dividends by the Company, the
existence of the liquidation account will not restrict the use or
application of such net worth. At December 31, 1996, the amount of the
remaining balance in this liquidation account was approximately
$4,371,000.
The Company may not declare or pay a cash dividend on, or repurchase
any of, its common stock if the effect thereof would cause the equity
of the Bank to be reduced below either the amount required for the
liquidation account or the net worth requirement imposed by the OTS.
The payment of dividends to the Company by the Bank is subject to OTS
regulations.
57
<PAGE>
Quarterly Results of Operations (Unaudited)
<TABLE>
<CAPTION>
For the Year Ended December 31, 1996
------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ------------ ------------ ------------
<S> <C>
Interest income............................ $ 5,793 $ 5,681 $ 5,823 $ 6,689
Interest expense........................... 3,577 3,375 3,376 4,005
------------ ------------ ------------ ------------
Net interest income before
provision for loan losses............ 2,216 2,306 2,447 2,684
Provision for loan losses.................. 22 0 0 6
------------ ------------ ------------ ------------
Net interest income after
provision for loan losses............ 2,194 2,306 2,447 2,678
Noninterest income......................... 160 234 241 306
General and administrative expense(1)...... 1,829 1,759 3,386 2,117
------------ ------------ ------------ ------------
Income (loss) before income tax expense.... 525 781 (698) 867
Income tax expense (benefit)............... 206 332 (278) 363
------------ ------------ ------------ ------------
Net income (loss).......................... $ 319 $ 449 $ (420) $ 504
============ ============ ============ ============
Net income (loss) per share................ $ .10 $ .14 $ (.13) $ .16
============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
For the Year Ended December 31, 1995
------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ------------ ------------ ------------
<S> <C>
Interest income............................ $ 5,461 $ 5,572 $ 5,622 $ 5,889
Interest expense........................... 3,371 3,532 3,630 3,694
------------ ------------ ------------ ------------
Net interest income before
provision for loan losses 2,090 2,040 1,992 2,195
Provision for loan losses(2)............... 40 65 85 473
------------ ------------ ------------ ------------
Net interest income after
provision for loan losses............ 2,050 1,975 1,907 1,722
Noninterest income......................... 274 (119) 180 238
General and administrative expense......... 1,713 1,792 1,785 1,850
------------ ------------ ------------ ------------
Income before income tax expense........... 611 64 302 110
Income tax expense......................... 241 30 113 30
------------ ------------ ------------ ------------
Net income................................. $ 370 $ 34 $ 189 $ 80
============ ============ ============ ============
Net income per share(3).................... $ .07 $ .01 $ .06 $ .03
============ ============ ============ ============
</TABLE>
(1) General and administrative expenses for the third quarter of 1996
included a non-recurring special insurance premium assessment of
$1.4 million.
(2) During the fourth quarter of 1995, the Company added substantially
to loan loss reserves
(3) The 1995 earnings per share computation was based on net income
from February 14, 1995, the date Monterey Bay Bank converted to a
federally chartered stock association and Monterey Bay Bancorp,
Inc. became the holding company for the Bank.
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
33-99112 on Form S-8 and Registration Statement No. 333-6859 on Form S-8 of
Monterey Bay Bancorp, Inc. of our report dated February 28, 1997, appearing in
this Annual Report on Form 10-K of Monterey Bay Bancorp, Inc. for the year ended
December 31, 1996.
Deloitte & Touche LLP
San Francisco, California
March 25, 1997
45
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000930429
<NAME> MBBC
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 4,228
<INT-BEARING-DEPOSITS> 948
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 166,565
<INVESTMENTS-CARRYING> 577
<INVESTMENTS-MARKET> 572
<LOANS> 234,519
<ALLOWANCE> (1,311)
<TOTAL-ASSETS> 425,762
<DEPOSITS> 318,145
<SHORT-TERM> 51,225
<LIABILITIES-OTHER> 2,051
<LONG-TERM> 8,582
0
0
<COMMON> 36
<OTHER-SE> 45,723
<TOTAL-LIABILITIES-AND-EQUITY> 425,762
<INTEREST-LOAN> 18,015
<INTEREST-INVEST> 5,971
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 23,986
<INTEREST-DEPOSIT> 10,949
<INTEREST-EXPENSE> 14,333
<INTEREST-INCOME-NET> 9,653
<LOAN-LOSSES> 28
<SECURITIES-GAINS> 168
<EXPENSE-OTHER> 9,091
<INCOME-PRETAX> 1,475
<INCOME-PRE-EXTRAORDINARY> 1,475
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 852
<EPS-PRIMARY> .27
<EPS-DILUTED> .27
<YIELD-ACTUAL> 7.46
<LOANS-NON> 1,393
<LOANS-PAST> 0
<LOANS-TROUBLED> 354
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,362
<CHARGE-OFFS> (133)
<RECOVERIES> 55
<ALLOWANCE-CLOSE> 1,311
<ALLOWANCE-DOMESTIC> 1,311
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
